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Questions and Answers
What does the Current Ratio evaluate in a business?
What does the Current Ratio evaluate in a business?
- A company's ability to meet short-term obligations (correct)
- A company's long-term financial stability
- A company's asset utilization efficiency
- A company's profitability over the long term
Which calculation is used to find the Return on Equity (ROE)?
Which calculation is used to find the Return on Equity (ROE)?
- Gross Profit / Revenue
- Total Revenue / Total Assets
- Net Income / Total Liabilities
- Net Income / Equity (correct)
Which financial metric is indicated by Gross Profit Margin?
Which financial metric is indicated by Gross Profit Margin?
- The efficiency of revenue generation
- The total expenses relative to revenue
- The proportion of revenue remaining after deducting COGS (correct)
- The total debt divided by total equity
What does a high Price-to-Earnings (P/E) Ratio generally suggest about a stock?
What does a high Price-to-Earnings (P/E) Ratio generally suggest about a stock?
How is the Gross Profit Margin calculated when given revenue and COGS?
How is the Gross Profit Margin calculated when given revenue and COGS?
If a company has a Debt-to-Equity Ratio of 1.5, what does this indicate?
If a company has a Debt-to-Equity Ratio of 1.5, what does this indicate?
Which of the following best describes why a company might have a low Current Ratio?
Which of the following best describes why a company might have a low Current Ratio?
What does it imply if a company's Gross Profit Margin is significantly lower than the industry average?
What does it imply if a company's Gross Profit Margin is significantly lower than the industry average?
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Study Notes
Financial Ratios and Their Importance
- Financial ratios help assess a company's financial health and performance.
- They provide insights into liquidity, profitability, and valuation.
Current Ratio
- Measures a company's ability to meet short-term obligations.
- Calculated using short-term assets divided by short-term liabilities.
- A higher current ratio indicates greater liquidity.
Return on Equity (ROE)
- A profitability measure reflecting how effectively equity is used to generate profit.
- Calculated as Net Income divided by Shareholder Equity.
- Example calculation: With a net income of $100,000 and equity of $500,000, ROE is 20%.
Gross Profit Margin
- Indicates how efficiently a company produces its goods relative to revenue.
- Calculated as (Revenue - Cost of Goods Sold) / Revenue.
- Example: If revenue is $1,000,000 and COGS is $600,000, the Gross Profit Margin is 40%.
Price-to-Earnings (P/E) Ratio
- Used to evaluate stock valuation.
- A high P/E ratio generally suggests that a stock is overvalued, indicating high future earnings growth expectations from investors.
- Understanding P/E ratios helps investors make informed decisions on stock purchases.
Summary of Key Concepts
- Current Ratio: Evaluates short-term liabilities coverage.
- ROE: Measures efficiency of equity in generating profits.
- Gross Profit Margin: Shows production efficiency and profitability.
- P/E Ratio: Indicates market expectations and stock valuation status.
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