Accounting Online Program Accounting Financial Ratios 5 — Questions and Answers
Question 1: The cash ratio is considered the most conservative liquidity measure because it:
- Includes all current assets in the calculation
- Only uses cash and cash equivalents in the numerator (Correct answer)
- Considers both receivables and inventory
- Accounts for projected future cash flows
Correct answer: Only uses cash and cash equivalents in the numerator
The cash ratio = (Cash + Cash Equivalents) / Current Liabilities, using only the most liquid assets.
Question 2: A company has 50,000 shares outstanding, net income of $200,000, and pays $50,000 in dividends. What is the earnings per share (EPS)?
- $1.00
- $2.00
- $3.00
- $4.00 (Correct answer)
Correct answer: $4.00
EPS = Net Income / Shares Outstanding = $200,000 / 50,000 = $4.00 per share.
Question 3: Which of the following correctly describes the relationship between the times interest earned ratio and financial risk?
- A higher ratio indicates greater financial risk
- A lower ratio indicates lower financial risk
- A higher ratio indicates the company can more easily service its debt (Correct answer)
- The ratio has no relationship to financial risk
Correct answer: A higher ratio indicates the company can more easily service its debt
A higher times interest earned ratio means EBIT covers interest expense more comfortably, signaling lower default risk.
Question 4: A company's accounts payable turnover ratio is 6. What is the average days payable outstanding (DPO)?
- 30 days
- 45 days
- 61 days (Correct answer)
- 90 days
Correct answer: 61 days
DPO = 365 / Accounts Payable Turnover = 365 / 6 ≈ 60.8 days.
Question 5: Which ratio best captures how effectively management uses all available resources to generate profit?
- Gross profit margin
- Return on assets (ROA) (Correct answer)
- Current ratio
- Debt-to-equity ratio
Correct answer: Return on assets (ROA)
ROA = Net Income / Average Total Assets, measuring how efficiently the entire asset base is used to generate earnings.
Question 6: A firm has a P/E ratio of 20 and earnings per share of $3. What is the market price per share?
- $20
- $40
- $60 (Correct answer)
- $80
Correct answer: $60
Market Price = P/E × EPS = 20 × $3 = $60.
Question 7: When comparing two companies, Company A has a higher net profit margin but lower asset turnover than Company B. Which conclusion is most accurate?
- Company A is always more profitable overall
- Company B necessarily has a higher ROE
- Their ROA could still be equal depending on the magnitude of each component (Correct answer)
- Company B has better control of its expenses
Correct answer: Their ROA could still be equal depending on the magnitude of each component
ROA = Net Profit Margin × Asset Turnover, so a higher margin can offset lower turnover and vice versa, potentially yielding the same ROA.
Accounting Online Program Accounting Financial Ratios 5
The cash ratio is considered the most conservative liquidity measure because it: