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Statement Analysis Tools and Accounting Ratios Test - 36

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Statement Analysis Tools and Accounting Ratios Test - 36
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  • Question 1
    1 / -0
    Match the following

    a. Test of Liquidity1. ROI
    b. Test of Solvency2. Acid test ratio
    c. Test of Activity3. Debt to Equity
    d. Test of Profitability4. Debtors Turnover ratio

    Solution
    1. Acid test ratio or Quick ratio is a much more conservative ratio than Current ratio. It measures the ability of the company to pay  the current debts  immediately and hence is a 'Test of Liquidity'.
    2. Debt to Equity ratio measures the mix of Debt and Equity funds in the company. This gives an idea regarding the solvency of the company. A high ratio points to less protection to the creditors and vice versa.
    3. Activity ratios are used to measure the efficiency of the firm at managing various resources.Debtors turnover ratio measures the efficiency with which the company manages its receivables and hence is a test of activity or activity ratio.
    4. ROI ( Return On Investment ) calculates the percentage return on the funds invested in the company and hence shows the profitability of the company.
  • Question 2
    1 / -0
    The immediate solvency ratio is                 .
    Solution
    Quick Ratio = [Current Assets- Inventory] / [Current liabilities - Bank Overdraft and Cash credit]
    While calculating quick ratio we reduce the amount of inventory as it is less liquid than the other current assets. The reason to reduce the amount of bank overdraft and cash credit is that mostly these are secured against inventory. So quick ratio gives us an immediate solvency ratio and is a much more conservative ratio than current ratio.
  • Question 3
    1 / -0
    ROI  is the ratio between                   .
    Solution
    ROI (Return On Investment ) = Net profit / Capital employed, it shows the profit made by the funds invested by the owners.
    If net profit = $$Rs. 150000$$ and Capital employed = $$Rs. 500000$$
    then ROI = $$150000 / 500000 $$
                    = $$0.3 : 1$$
  • Question 4
    1 / -0
    Which of the following ratios is a favorable indication, if it is low?
    Solution
    1. Stock turnover ratio is the relationship between the COGS and the average inventory. It indicates how fast the inventory is sold or used. A high ratio is favorable from the point of view of liquidity and vice versa.
    2. Operating profit ratio is the ratio between operating profit and the net sales .Higher the ratio, higher would be the operating profit and it would be more favorable.
    3. Fixed assets turnover ratio measures the efficiency with which the firm utilizes its fixed assets for generating its sales. A high ratio means higher efficiency.
    4. Operating ratio is the ratio of operating expenses to the net sales. Higher this ratio higher would be the operating expense and lower the operating profit. So a lower ratio is more favorable in terms of business.
  • Question 5
    1 / -0
    Current ratio is increased by :
    1) Issue of redeemable debentures.
    2) Selling of old machine for cash.
    3) Converting debentures into equity capital.
    4) Cash received from debtors.
    Solution
    Current ratio = Current assets/ Current liabilities

    1. When Redeemable debentures are issued, long term liabilities and the current assets increase,while  the current liabilities remain constant so  the current ratio would increase.
    2. When old machine is sold for cash, fixed assets would decrease and the current assets would increase, while  the current liabilities remain constant so  the current ratio would increase.
    3. When debentures are converted into equity capital there would be no changes in the current assets and the current liabilities and ultimately no change in the current ratio.
    4. When cash is received from debtors there would be no net changes on the current assets as the cash balance would increase and the debtors balance would decrease by the same amount and hence there would no change in the current ratio.
  • Question 6
    1 / -0
    Gross profit may be increased by :
    1) Increasing selling price
    2) Reducing cost of sales
    3) Increasing sales of items with higher margin
    4) Increasing cost of sales
    Solution
    1. Everything else remaining constant when the selling price is increased it would lead to a higher sales amount and in effect a higher gross profit.
    2. Everything remaining constant when the cost of sale is reduced the gross profit would increase, because Sales minus Cost of Sales = Gross profit.
    3. When sales of items with higher margin are increased it would ultimately lead to a higher sales figure and hence higher gross profit.
    4. Everything remaining constant when the cost of sale is increased the gross profit would decrease, because Sales minus Cost of Sales = Gross profit.
  • Question 7
    1 / -0
    If gross profit ratio is $$25\%$$ on cost, it is _________ $$\%$$ on sales.
    Solution
    Cost + Gross profit = Sales
    Let cost = $$100$$ and Gross profit ratio = $$25\%$$ on cost
    Therefore Gross profit = $$25\%$$ x $$100$$ = $$25$$
    So, $$100 + 25$$ = Sales
    Sales = $$125$$
    Gross profit as percentage on sales = [Gross profit/Sales] x $$100$$
                                                                 = [$$25/125$$] x $$100$$
                                                                  = $$20\%$$.
  • Question 8
    1 / -0
    Large inventory accumulation is anticipation of price rise in future.
  • Question 9
    1 / -0
    Borrowing from short term and investing in long term assets indicated by _________________.
  • Question 10
    1 / -0
    Long term solvency is indicated by                    .
    Solution
    Debt equity ratio measures the debt funds funds with respect to the equity. A high ratio means less security to the creditors, because a high ratio would indicate that the debt funds are more than the equity funds and while paying off the liabilities less funds would be available to pay off the creditors and hence the solvency would be low and vice versa. Therefore we can say that long term solvency is indicate by Debt equity ratio.
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