Skip to main content
Pearson+ LogoPearson+ Logo
Back

Introduction to Ratios quiz #1

Control buttons has been changed to "navigation" mode.
1/40
  • What is a financial ratio and why is it important in financial analysis?
    A financial ratio is a calculation where one financial number is divided by another, helping companies and investors make informed decisions by analyzing relationships between different financial statement items.
  • List and briefly describe the five main categories of financial ratios.
    The five main categories are: liquidity (solvency) ratios, financial leverage ratios, efficiency ratios, profitability ratios, and market value ratios.
  • What do liquidity or solvency ratios measure?
    Liquidity or solvency ratios measure a company's ability to pay its short-term obligations using its current assets.
  • What is the focus of financial leverage ratios?
    Financial leverage ratios focus on a company's ability to manage and pay off its long-term debts.
  • How do efficiency ratios help in financial analysis?
    Efficiency ratios assess how effectively a company uses its assets and liabilities to generate sales and manage operations.
  • What do profitability ratios indicate about a company?
    Profitability ratios indicate how much profit a company generates relative to its revenue, assets, or equity.
  • What is the purpose of market value ratios?
    Market value ratios help investors evaluate a company's stock price relative to its earnings, book value, or other financial metrics.
  • How is a ratio generally calculated in financial analysis?
    A ratio is calculated by dividing one number (the numerator) by another number (the denominator), which may involve additional calculations.
  • How should you interpret a ratio result, such as 1.54?
    A ratio of 1.54 means that for every one unit of the denominator, there are 1.54 units of the numerator.
  • What are three common methods for analyzing financial ratios?
    Three methods are: comparing to set thresholds, benchmarking against other companies or industry averages, and comparing to prior periods.
  • Why might a ratio have a threshold, and what does it indicate?
    A ratio may have a threshold to signal a minimum or maximum acceptable value; falling outside this range can indicate potential financial problems.
  • What is benchmarking in the context of ratio analysis?
    Benchmarking involves comparing a company's ratios to those of competitors or industry averages to assess relative performance.
  • How can comparing ratios to prior periods be useful?
    Comparing ratios to prior periods helps identify trends and changes in a company's financial performance over time.
  • Provide an example of a non-accounting ratio and explain its interpretation.
    If Julie eats 50 oranges and 20 apples, her orange-to-apple ratio is 2.5, meaning she eats 2.5 oranges for every apple.
  • If the industry average orange-to-apple ratio is 1.5 and Julie's is 2.5, what does this suggest?
    It suggests Julie prefers oranges more than the average fruit enthusiast, as her ratio is higher.
  • What does it mean if a ratio is less than 1?
    A ratio less than 1 means there are fewer units of the numerator than the denominator for each unit of the denominator.
  • Why is it important to analyze ratios after calculating them?
    Analyzing ratios provides context and meaning, helping to identify strengths, weaknesses, and trends in financial performance.
  • Can the numerator or denominator in a ratio involve more than one number? Explain.
    Yes, the numerator or denominator can involve sums or differences of multiple numbers, not just single values.
  • What is the difference between book value and market value in the context of market value ratios?
    Book value is the historical cost recorded on the balance sheet, while market value reflects the current price in the open market.
  • How does the use of ratios benefit investors?
    Ratios help investors assess a company's financial health, profitability, and market value, aiding investment decisions.
  • What is the significance of the denominator in a ratio?
    The denominator represents the base unit, and the ratio shows how many units of the numerator exist for each unit of the denominator.
  • Why might a company compare its ratios to those of competitors?
    Comparing to competitors helps a company understand its relative position in the industry and identify areas for improvement.
  • What does a ratio of exactly 1 indicate?
    A ratio of 1 indicates that the numerator and denominator are equal in value.
  • How can ratio analysis help identify red flags in a company's financial statements?
    Unusual or out-of-threshold ratios can signal financial distress, inefficiency, or other problems requiring further investigation.
  • What is the first step in performing ratio analysis?
    The first step is to calculate the relevant ratios using data from the company's financial statements.
  • How does the concept of ratios apply to both accounting and non-accounting scenarios?
    Ratios express relationships between quantities, making them useful for analyzing both financial data and everyday situations.
  • What is meant by the term 'turnover ratios' in efficiency ratios?
    Turnover ratios measure how efficiently a company uses its assets, such as inventory or receivables, to generate sales.
  • Why is it important to use more than one method when analyzing ratios?
    Using multiple methods provides a more comprehensive understanding and reduces the risk of misinterpretation.
  • What does it mean to set a threshold for a ratio, and how is it determined?
    Setting a threshold means establishing a minimum or maximum acceptable value, often based on industry standards or company policy.
  • How can ratio analysis assist in trend analysis?
    By comparing ratios over multiple periods, analysts can identify positive or negative trends in a company's performance.
  • What is the role of ratios in decision-making for companies?
    Ratios provide insights into financial health and performance, supporting strategic and operational decision-making.
  • How does dividing by 1 help interpret a ratio?
    Dividing by 1 clarifies that the ratio shows how many units of the numerator exist for each single unit of the denominator.
  • What is the practical value of using ratios in financial analysis?
    Ratios simplify complex financial data, making it easier to compare, interpret, and communicate financial performance.
  • How can ratio analysis reveal a company's preferences or strategies?
    Ratios can highlight areas of focus, such as higher investment in certain assets or greater emphasis on profitability.
  • What is the significance of comparing a company's ratio to the industry average?
    It helps determine if the company is performing above, below, or in line with industry standards.
  • Why is it important to understand both the calculation and interpretation of ratios?
    Understanding both ensures accurate analysis and meaningful conclusions from financial data.
  • How can a ratio be expressed as a decimal, and what does this mean?
    A ratio is often expressed as a decimal (e.g., 2.5), indicating the number of numerator units per one denominator unit.
  • What is the relationship between ratios and financial statements?
    Ratios are derived from financial statement data and provide insights into a company's financial condition.
  • How does ratio analysis support benchmarking?
    It allows companies to compare their performance metrics to those of peers or industry standards.
  • What is the main takeaway from the example of Julie's fruit eating habits?
    The example demonstrates how to calculate and interpret a ratio, and how comparison to an average provides additional insight.