Chapter 6: Ratios and Metrics

Question 1

1. What is liquidity?

Answer 1

Liquidity measures a company’s ability to meet its short-term obligations using its available assets. For example, a company with $10,000 in cash and $8,000 in short-term liabilities is considered liquid because it can cover its debts easily.

Question 2

2. What is solvency?

Answer 2

Solvency measures a company’s ability to meet its long-term obligations. It focuses on overall financial health rather than just short-term cash flow. For instance, a business with significant equity and manageable debt is considered solvent.

Question 3

3. What is the debt-to-equity ratio?

Answer 3

The debt-to-equity ratio shows how much a company relies on debt compared to equity for financing. It’s calculated as:
Debt-to-Equity Ratio=Total Liabilities/Total Equity

Question 4

4. What is return on assets (ROA)?

Answer 4

ROA measures how efficiently a company uses its assets to generate profit. It’s calculated as:
ROA=Net Income/Total Assets

Question 5

5. What is return on equity (ROE)?

Answer 5

ROE measures how effectively a company uses shareholders’ equity to generate profits. It’s calculated as:
ROE=Net Income/Shareholders’ Equity

Question 6

6. What is earnings per share (EPS)?

Answer 6

EPS measures the profit allocated to each share of stock. It’s calculated as:
EPS=Net Income - Dividends on Preferred Stock/Number of Outstanding Shares

Question 7

7. What is inventory turnover?

Answer 7

Inventory turnover measures how efficiently a company sells and replaces its inventory. It’s calculated as:
Inventory Turnover=Cost of Goods Sold (COGS)/Average Inventory

Question 8

8. What is the current ratio?

Answer 8

The current ratio measures a company’s ability to pay short-term obligations with its current assets. It’s calculated as:
Current Ratio=Current Assets/Current Liabilities

Question 9

9. What is the quick ratio?

Answer 9

The quick ratio, or acid-test ratio, measures a company’s ability to pay short-term liabilities using its most liquid assets (excluding inventory). It’s calculated as:
Quick Ratio=(Current Assets – Inventory)/Current Liabilities

Question 10

10. Why are ratios and metrics important?

Answer 10

Ratios and metrics help businesses assess financial health, efficiency, and profitability. For instance:
* Liquidity ratios show if a company can handle short-term debts.
* Profitability ratios indicate how well a company generates profits.
These tools help businesses and investors make informed decisions.