IFA IFA Financial Analysis & Decision Making 1 — Questions and Answers
Question 1: What does a current ratio of less than 1 indicate?
- The company has more equity than debt
- The company has more current liabilities than current assets (Correct answer)
- The company is highly profitable
- The company has no long-term debt
Correct answer: The company has more current liabilities than current assets
A current ratio below 1 means the company's current liabilities exceed its current assets, indicating potential short-term liquidity problems.
Question 2: Which financial ratio measures how efficiently a company uses its assets to generate revenue?
- Debt-to-equity ratio
- Net profit margin
- Asset turnover ratio (Correct answer)
- Price-to-earnings ratio
Correct answer: Asset turnover ratio
The asset turnover ratio (Revenue ÷ Total Assets) measures how effectively a company generates sales from its asset base.
Question 3: What does EBITDA stand for and why is it used?
- Earnings Before Interest, Taxes, Dividends, and Amortization — measures cash flow
- Earnings Before Interest, Taxes, Depreciation, and Amortization — approximates operating cash flow (Correct answer)
- Estimated Business Income Tax and Depreciation Allowance
- Equity Before Income Tax, Dividends, and Assets
Correct answer: Earnings Before Interest, Taxes, Depreciation, and Amortization — approximates operating cash flow
EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization) is used to approximate operating cash generation, stripping out financing and accounting choices.
Question 4: A company's gross profit margin has fallen from 45% to 32%. This most likely indicates:
- Improved operating efficiency
- Rising cost of goods sold or falling selling prices (Correct answer)
- Lower tax liability
- Increased capital expenditure
Correct answer: Rising cost of goods sold or falling selling prices
A declining gross profit margin typically signals rising production costs, increased cost of goods sold, or pressure on selling prices eroding margin.
Question 5: What is the purpose of horizontal analysis in financial statement analysis?
- Comparing line items across different companies
- Comparing financial data across multiple periods to identify trends (Correct answer)
- Expressing each line item as a percentage of a base figure
- Analyzing only balance sheet items
Correct answer: Comparing financial data across multiple periods to identify trends
Horizontal analysis compares financial data over multiple time periods, identifying trends, growth rates, and changes in absolute values.
Question 6: Which ratio best measures a company's ability to meet its immediate short-term obligations without selling inventory?
- Current ratio
- Quick (acid-test) ratio (Correct answer)
- Debt ratio
- Return on equity
Correct answer: Quick (acid-test) ratio
The quick ratio excludes inventory from current assets (Cash + Receivables ÷ Current Liabilities), providing a stricter liquidity measure than the current ratio.
IFA IFA Financial Analysis & Decision Making 1
What does a current ratio of less than 1 indicate?