Ratios

Question 1

What do we use ratios to measure?

Answer 1

Liquidity, Stability and profitability

Question 2

What is liquidity

Answer 2

The ability of a business to pay its debts as they fall due

Question 3

What is stability

Answer 3

The ability of a business to survive in the long term

Question 4

What is profitability

Answer 4

The ability of a business to make an acceptable level of profit.

Question 5

What are current ratios

Answer 5

Current Ratios ( the measure of the ability of a business to pay its short-term debts, that is debts payable in 12 months or less)

Question 6

Current Ratios Formula

Answer 6

Current Assets / Current liabilities x 100

Question 7

Meaning when CR is < 100%

Answer 7

Indicates either that a business may find it difficult to pay its short-term debts or that the business is operating in an industry in which money is collected from sales very quickly

Question 8

Meaning when CR is beween 100% and 200%

Answer 8

Indicates that a business should be able to pay its short-term debts

Question 9

Meaning when CR is >100%

Answer 9

Indicates that a business should be able to pay its short-term debts and that the business has extra current assets available (wasted) excess

Question 10

Quick Asset Ratio

Answer 10

A measure of the ability of a business to pay its more urgently repayable current liabilities using ONLY its more liquid current assets.

Question 11

Quick Asset formula

Answer 11

Current assets except for inventory and prepaid expenses/ Current liabilities except for bank overdraft x 100

Question 12

Quick Asset > 100%

Answer 12

Indicates that a business should be able to pay its short-term debts.

Question 13

Quick Asset <100%

Answer 13

Indicates that in an emergency, a business may not be able to pay its short-term debts

Question 14

What is Gearing?

Answer 14

Term used to describe the extent of the borrowings of a business.
-A highly geared business has large interest and loan repayments and has an increased risk of failure

Question 15

Debit to Equity Ratio

Answer 15

Measures the gearing of a business

Question 16

Debit to Equity Ratio formula

Answer 16

Total liabilities/ Equity x 100

Question 17

Debit to equiy ratio interpretation

Answer 17

• No acceptable figure for the debt-to-equity ratio.
• Small business may need to have a debt-to-equity ratio of about 70% or less.
• larger business may successfully operate with a debt-to-equity ratio of 100% to 200% or even higher

Question 18

Profitability Ratio measuring

Answer 18

Four ratios that can be used as a measure of profitability are:
- Gross profit ratio
- Profit ratio
- Expense ratio
- Return on asset

Question 19

Gross Profit ratio

Answer 19

Shows the percentage of gross profit that is contained in each dollar of sales

Question 20

Gross Profit formula

Answer 20

Gross Profit / Net sales x 100

Question 21

An increase in this year’s gross profit could be caused by?

Answer 21

a) Increase in selling price of the inventory greater than any increase in purchase price of the inventory
b) Purchasing of inventory at a low price

Question 22

A decrease in this year’s gross profit could be caused by?

Answer 22

1) A decrease in the selling price of the inventory due to:
a) New competitors entering the market
b) A price war between competing businesses
c) A plan to increase market share by selling inventory at a cheaper price
2) An increase in the purchase price of the inventory greater than any increase in the selling price of the inventory.

Question 23

Profit Ratio

Answer 23

The profit ratio shows the percentage of profit in each dollar of sales.

Question 24

Profit Ratio Formula

Answer 24

Profit / sales x 100

Question 25

Meaning of Profit ratio

Answer 25

Increase = Increase in the gross profit ratio or a reduction in expenses

Decrease = expense increases that are not being fully passed on to consumers in the form of increased selling prices or increased competition causing the business to lower its selling prices.

Question 26

Expense ratio

Answer 26

The expense ratio compares the sales of a business to the total of the selling and distribution, general and administration, and financial expenses.

Question 27

Expense ratio formula

Answer 27

Expenses( other than COS) / Net Sales x 100

Question 28

Return ratio

Answer 28

The return on assets measures how efficiently a business uses its assets to generate a profit

Question 29

Return ratio Formula

Answer 29

Profit / Average Assets x 100