Chapter 9 Flashcards
What is the primary purpose of financial ratios?
To assess a company’s financial performance by analyzing profitability, liquidity, solvency, and efficiency.
How do profitability ratios help in financial analysis?
They measure a company’s ability to generate profit relative to its revenue, assets, or equity.
What does the gross profit percentage indicate?
It shows the percentage of revenue remaining after deducting the cost of goods sold, indicating pricing efficiency.
How is the net profit percentage different from the gross profit percentage?
It accounts for all operating expenses, taxes, and interest, reflecting the company’s overall profitability.
Why is return on capital employed (ROCE) an important metric?
It measures how efficiently a company uses its capital to generate profit.
What does a high stock turnover ratio indicate?
Efficient inventory management with frequent stock movement, reducing storage costs.
How do gearing ratios measure financial risk?
They compare long-term borrowings to shareholders’ equity, indicating leverage and financial stability.
What is the current ratio, and what does it measure?
It measures liquidity by comparing current assets to current liabilities, assessing short-term solvency.
How does the quick ratio differ from the current ratio?
It excludes inventory from current assets, providing a stricter measure of liquidity.
What is the combined ratio in insurance?
It is the sum of claims, commission, and expense ratios, assessing underwriting profitability.
Why is the solvency ratio critical for insurance companies?
It ensures the company has enough capital to cover outstanding claims and liabilities.
How does the return on equity (ROE) measure an insurer’s efficiency?
It evaluates profitability in relation to shareholder investments.
What does a high ratio of outstanding claims to net assets suggest?
A higher claims burden, which could indicate financial stress.
Why might financial ratios be misleading if used in isolation?
They depend on financial reporting accuracy and may not reflect future performance.
How do financial ratios assist in benchmarking?
They allow comparison of performance between companies and industry standards.
What limitations exist in using financial ratios for decision-making?
Ratios can be affected by accounting policies, economic changes, and one-time events.
Why is the creditors’ payment period ratio important for a company?
It shows how long a company takes to pay suppliers, affecting cash flow management
How does a high debtor turnover ratio benefit a business?
It indicates faster collection of receivables, improving liquidity.
What could cause a decrease in the gross profit percentage?
Higher production costs, lower selling prices, or increased competition.
Which financial ratio measures a company’s ability to meet short-term liabilities?
a) Gearing ratio
b) Current ratio
c) Return on assets
d) Profit margin
b) Current ratio
What does a high stock turnover ratio indicate?
a) Low profitability
b) Efficient inventory management
c) High credit risk
d) Poor liquidity
b) Efficient inventory management
How is return on capital employed (ROCE) calculated?
a) Net profit / Revenue
b) Operating profit / Capital employed
c) Net profit / Shareholder’s equity
d) Current assets / Current liabilities
b) Operating profit / Capital employed
What does the quick ratio exclude from current assets?
a) Accounts receivable
b) Inventory
c) Cash
d) Investments
b) Inventory
If an insurance company’s combined ratio is above 100%, what does it indicate?
a) Underwriting loss
b) Profitability
c) Strong liquidity
d) High solvency
a) Underwriting loss
Which ratio measures a company’s reliance on debt for financing?
a) Return on equity
b) Gearing ratio
c) Current ratio
d) Profit margin
b) Gearing ratio
What does a high total liabilities to cash plus investments ratio indicate?
Potential liquidity risk, as liabilities may exceed liquid assets.
What does the solvency ratio assess?
a) Liquidity risk
b) Profitability
c) Financial stability of an insurer
d) Claim frequency
c) Financial stability of an insurer
Why is a high debtor turnover ratio beneficial?
a) Increases profitability
b) Ensures quick cash inflows
c) Reduces creditor payments
d) Lowers gross profit percentage
b) Ensures quick cash inflows
Which ratio is most useful in assessing an insurance company’s risk exposure?
a) Profit margin
b) Return on assets
c) Ratio of outstanding claims to net assets
d) Stock turnover ratio
c) Ratio of outstanding claims to net assets
If a company has a current ratio below 1, what does this suggest?
a) Strong liquidity
b) Potential short-term financial difficulty
c) High profitability
d) Low gearing
b) Potential short-term financial difficulty
Which ratio best measures an insurer’s underwriting profitability?
a) Current ratio
b) Loss ratio
c) Return on assets
d) Gearing ratio
b) Loss ratio
A company’s quick ratio is 0.8. What does this suggest?
a) Strong liquidity
b) Potential cash flow issues
c) High profitability
d) Overstated reserves
b) Potential cash flow issues
Which financial ratio compares long-term debt to shareholders’ equity?
a) Gearing ratio
b) Combined ratio
c) Liquidity ratio
d) Solvency ratio
a) Gearing ratio
What does an increase in a company’s debtor collection period indicate?
a) Improved cash flow
b) Higher liquidity
c) Slower cash inflows
d) Higher profitability
c) Slower cash inflows
If an insurer has a solvency ratio below regulatory requirements, what is the likely consequence?
a) Higher investment returns
b) Regulatory intervention
c) Increased underwriting profits
d) Better liquidity
b) Regulatory intervention
What is the impact of a rising loss ratio on an insurer?
a) Higher underwriting profitability
b) Increased claims costs
c) Lower reserve requirements
d) Better capital efficiency
b) Increased claims costs
A very high creditors’ payment period may indicate that a company is:
a) Paying suppliers late
b) Highly profitable
c) Managing inventory efficiently
d) Increasing reserves
a) Paying suppliers late
Which ratio measures the efficiency of an insurer in utilizing its capital to generate profit?
a) Quick ratio
b) Return on equity
c) Combined ratio
d) Gearing ratio
b) Return on equity
What does a combined ratio of exactly 100% indicate?
a) Underwriting loss
b) Break-even underwriting performance
c) High solvency
d) Low liquidity risk
b) Break-even underwriting performance
If a company’s stock turnover ratio declines, what could be a possible cause?
a) Faster inventory movement
b) Higher revenue growth
c) Excess inventory buildup
d) Lower creditor payments
C) Excess inventory buildup
