Financial Statement Ratio Analysis
Self Test
Introduction to Accounting
Financial Statement Ratio Analysis
Self Test
Click the “Check Your Answer” box below each question to reveal the correct answer and explanation.
1. Ratio analysis is most useful for
a. comparing companies that are the same size
b. comparing companies that are different sizes
c. comparing companies that are in a different industry
d. trend analysis when done for one year only
Answer
B. Ratio analysis is most useful for comparing companies of different sizes in the same industry. Ratio analysis can illustrate trends if done for more than one year. Companies of the same size can be directly compared without doing ratio analysis.
2. To be useful, financial ratios should be compared to
a. industry benchmarks
b. the income statement
c. the balance sheet
d. the amount of cash on hand
Answer
A. Industry benchmarks should be used when doing ratio analysis. Companies in different industries require different levels of assets to support the business and also operate at different expected profit margins.
3. Which ratio indicates the most immediate liquidity of the company?
a. current ratio
b. quick ratio
c. debt to equity
d. return on assets
Answer
B. The quick ratio uses cash, accounts receivable, short-term investments and current liabilities. These are the most current assets. All other ratios include assets or liabilities that take longer to impact cash.
4. Which ratio indicates the % return on each dollar invested by owners?
a. debt to equity
b. current ratio
c. return on equity
d. total liabilities to total assets
Answer
C. Equity represents dollars invested in the company by owners. Return on equity indicates the return on the dollars invested.
5. Which ratio indicates how efficiently assets are being used?
a. profit margin
b. earnings per share
c. return on equity
d. return on assets
Answer
D. Return on assets indicates the earnings from funds invested in assets. The higher the return, the more efficiently assets are being used.
6. Which ratio represents the earnings for one share of common stock?
a. price to earnings
b. earnings per share
c. profit margin
d. net income per equity
Answer
B. Earnings per share represents the amount that is earned by one share of common stock. Price to earnings represents the fair market value of one share compared to earnings for one share. Profit margin indicates the earnings on sales dollars. Net income per equity is not a common ratio that is used by investors or creditors.
7. Which ratio indicates how many days it takes to collect from customers?
a. return on assets
b, inventory turnover
c. accounts receivable turnover
d. quick ratio
Answer
C. Accounts receivable turnover estimates how many days on average it takes to collect from customers. Accounts receivable is the amount customers owe the company.
8. Which ratio indicates how many days goods for sale to customers are stored in the warehouse before they are sold?
a. return on assets
b, inventory turnover
c. accounts receivable turnover
d. quick ratio
Answer
C. Inventory turnover estimates how many days on average inventory sits in the warehouse before it is sold to customers. Inventory is sold to customers. Return on assets and quick ratio include other assets besides inventory.
9. Which common ratio indicates the part of every sales dollar that becomes net income?
a. operating percent
b, sales turnover
c. accounts receivable turnover
d. profit margin
Answer
D. Profit margin indicates the amount of every sales dollar that results in net income. Operating percent and sales turnover are not common ratios.
10. Which ratio is used to estimate if a share of common stock is overpriced?
a. profit margin
b. return on assets
c. return on equity
d. price to earnings
Answer
D. Price to earnings measures the fair market value of a share of common stock compared to earnings for one share of common stock. It often indicates an estimated growth percentage. All other ratios listed are not for one share of common stock.
11. Which ratio would be used to determine if a company is able to pay current liabilities?
a. profit margin
b. return on liabilities
c. return on equity
d. current ratio
Answer
D. The current ratio indicates how much greater current assets are than current liabilities. Current assets are used to pay current liabilities and current assets should be higher than current liabilities to be able to repay current liabilities.
12. Which ratio is used to determine if a company relies on borrowings for financing the company?
a. debt margin
b. return on equity
c. return on assets
d. debt to equity
Answer
D. Debt to equity measures if the company has financed operations with debt (borrow) or equity (from owners.) When the ratio is higher than 1 it indicates the company has more debt than equity. Debt margin is not a common ratio. Return on equity and return on assets do not have borrowings in the ratio.
13. What ratio is used to determine if a company owns its assets?
a. current ratio
b. total liabilities to total assets
c. return on assets
d. profit margin
Answer
B. Total liabilities to total assets indicate what percent of total assets are not owned. The lower the ratio, the higher the percent of assets owned.
14. Which ratio is used to project net income for a projected sales increase?
a. profit margin
b. return on assets
c. return on equity
d. current ratio
Answer
A. Profit margin is the percent of every sales dollar that results in income. The increase in sales can be multiplied by the change in sales to estimate the net income that could result. Return on assets and return on equity are not used to project income because income is part of the ratio.
15. Which ratio indicates if the company offers an adequate return to investors?
a. profit margin
b. inventory turnover
c. return on equity
d. current ratio
Answer
C. Return on equity indicates the percent return to investors. Equity is owned by investors. Profit margin indicates the return on sales.