Financial ratio analysis exam review

What is the current ratio?

A liquidity ratio measuring a company's ability to pay short-term obligations. Formula: Current Ratio = Current Assets / Current Liabilities.

What does a current ratio of 2.0 indicate?

The company has $\displaystyle 2 in current assets for every$1 in current liabilities, suggesting good liquidity.

Quick ratio vs. current ratio?

Quick Ratio: excludes inventory. Current Ratio: includes all current assets.

True or False: A higher quick ratio means better liquidity.

True: A higher quick ratio indicates the company can cover its short-term liabilities without selling inventory.

Fill in the blank: The __________ measures profitability relative to total assets.

Return on Assets (ROA)

What is the formula for Return on Equity (ROE)?

ROE = Net Income / Shareholder's Equity

Define gross profit margin.

Gross Profit Margin = (Gross Profit / Revenue) x 100. It shows the percentage of revenue exceeding the cost of goods sold.

How do you calculate the debt-to-equity ratio?

Debt-to-Equity Ratio = Total Liabilities / Shareholder's Equity. It indicates the relative proportion of shareholders' equity and debt used to finance a company's assets.

Operating margin definition?

Operating Margin = Operating Income / Revenue. It measures the efficiency of a company in managing its core business operations.

True or False: A declining net profit margin is always bad.

False: It could indicate increased costs, but could also mean more investment in growth.

What does the price-to-earnings (P/E) ratio indicate?

The P/E ratio indicates how much investors are willing to pay per dollar of earnings, calculated as Price per Share / Earnings per Share.

Cause → Effect: Rising interest rates lead to __________.

Higher debt service costs, reducing net income.

What is the formula for the return on investment (ROI)?

ROI = (Net Profit / Cost of Investment) x 100. It measures the gain or loss generated relative to the investment cost.

What is EBITDA?

Earnings Before Interest, Taxes, Depreciation, and Amortization; a measure of a company's overall financial performance.

What does a negative free cash flow indicate?

It suggests the company is spending more on capital expenditures than it produces in cash, potentially a warning sign.

What does the current ratio measure?

The current ratio measures a company's ability to pay short-term obligations with current assets. Formula: Current Ratio = Current Assets / Current Liabilities.

True or False: A higher debt-to-equity ratio indicates more risk.

True. It suggests a company is financing more of its operations through debt, which can increase financial risk.

Fill in the blank: The formula for ROE is _____.

ROE = Net Income / Shareholder's Equity.

Compare gross profit margin and net profit margin.

Gross profit margin shows profitability after production costs, while net profit margin includes all expenses, showing the overall profitability.

What is the significance of the price-to-earnings ratio?

The price-to-earnings (P/E) ratio indicates how much investors are willing to pay per dollar of earnings, reflecting growth expectations.

Calculate the quick ratio: Current Assets = $\displaystyle 150, Inventory =$50, Current Liabilities = $100.

Quick Ratio = (Current Assets - Inventory) / Current Liabilities = (150 - 50) / 100 = 1.0.

What does return on assets (ROA) indicate?

ROA indicates how efficiently a company uses its assets to generate net income. Formula: ROA = Net Income / Total Assets.

True or False: A low current ratio is always bad.

False. While a low current ratio may indicate liquidity issues, industry norms vary; some industries operate successfully with lower ratios.

Define working capital.

Working Capital = Current Assets - Current Liabilities. It measures short-term financial health.

What is the debt ratio?

The debt ratio measures the proportion of a company's assets financed by debt. Formula: Debt Ratio = Total Debt / Total Assets.

Fill in the blank: A high inventory turnover ratio indicates _____.

A high inventory turnover ratio indicates efficient inventory management and strong sales.

How do you interpret a P/E ratio of 15?

A P/E ratio of 15 means investors are willing to pay $\displaystyle 15 for every$1 of earnings, suggesting moderate growth expectations.

What does the times interest earned ratio signify?

Times Interest Earned Ratio measures a company's ability to meet interest obligations. Formula: TIE = EBIT / Interest Expense.

True or False: A high dividend yield is always a good sign.

False. A high dividend yield may indicate a struggling stock price rather than good financial health.

What does the debt-to-assets ratio indicate?

It measures the proportion of a company's assets financed by debt. - Formula: $\displaystyle \frac{Total\,Debt}{Total\,Assets}$ - A higher ratio suggests more financial risk.