Chapter 5: Financial Ratios

Question 1

company’s cash position and its ability to pay its bills as the come due

Answer 1

Liquidity

Question 2

Formula of Current ratio

Answer 2

=current assets / current liabilities

Question 3

Formula of Quick Ratio

Answer 3

= (current assets –inventory- prepaid expenses) / current liabilities

Question 4

eliminates inventory as it could be stale, worn or not saleable

Answer 4

Quick ratio

Question 5

is the ability of a business to pay its long- term obligations

Answer 5

Solvency

Question 6

indication of long term solvency

Answer 6

Leverage ratios

Question 7

indicates the amount of capital or resources financed by creditors and the amount provided by owners

Answer 7

Financial Structure

Question 8

refers to the ability of a business to invest excess available resources or raise needed funds through borrowings without difficulty in times of need

Answer 8

Capacity for Adaptation

Question 9

LEVERAGE RATIOS

Answer 9

• DEBT RATIO
• EQUITY RATIO
• TIMES INTERES EARNED RATIO

Question 10

the percentage assets funded by creditors

Answer 10

DEBT RATIO

Question 11

Formula of Debt Ratio

Answer 11

= total liabilities/ total assets

Question 12

the percentage of assets funded by the owners

Answer 12

EQUITY RATIO

Question 13

Formula of Equity Ratio

Answer 13

= total equity/total assets

Question 14

extend to which a company’s operations cover the interest expense

Answer 14

TIMES INTEREST EARNED RATIO

Question 15

Formula of Time Interest Earned Ratio

Answer 15

= operating income/interest expense

Question 16

PROFITABILITY RATIOS

Answer 16

• Gross profit margin
• Operating profit margin
• Net profit margin or return on sales

Question 17

assess financial health

Answer 17

Gross profit margin

Question 18

Formula of Gross profit margin

Answer 18

= gross profit/net sales

Question 19

revenues left after variable/operating costs

Answer 19

Operating profit margin

Question 20

Formula of Operating profit margin

Answer 20

= operating profit/net sales

Question 21

over all profitability of the company

Answer 21

Net profit margin or return on sales

Question 22

Formula of Net profit margin or return on sales

Answer 22

= income each peso of sales generate – net income/net sales

Question 23

Disadvantages of Financial ratios

Answer 23

• Large firms has different divisions in different industries(industry- average ratios may be difficult)
• Inflation and increasing prices may distort balance
• Seasonal factors affects income statement
• A company may have good and bad ratios making it difficult to tell if a company is weak or strong

Question 24

Compute ratios

Answer 24

• dividend pay-out
• plowback ratio

Question 25

cash dividends/net income

Answer 25

pay- out ratio

Question 26

opposite of pay-out ratio. The portion of income that does not get paid out as dividends. Retention ratio.

Answer 26

plowback ratio

Question 27

Profitability Ratio

Answer 27

• Return on Sales (ROS) = profit after taxes sales
• Return on Equity (ROE) = profit after taxes owner’s equity
• Return on Assets (ROA) = profit after taxes total assets

Question 28

• Return on Sales (ROS)

Answer 28

= profit after taxes / sales

Question 29

• Return on Equity (ROE)

Answer 29

= profit after taxes / owner’s equity

Question 30

• Return on Assets (ROA)

Answer 30

= profit after taxes / total assets