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Questions and Answers
The current ratio measures a company's ability to pay its debts over the next 5 years.
The current ratio measures a company's ability to pay its debts over the next 5 years.
False
A higher current ratio indicates a company is less liquid.
A higher current ratio indicates a company is less liquid.
False
The quick ratio is also known as the acid-test ratio or quick assets ratio.
The quick ratio is also known as the acid-test ratio or quick assets ratio.
True
A commonly acceptable current ratio is 1.
A commonly acceptable current ratio is 1.
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Liquidity ratios measure a company's ability to meet its long-term debt obligations.
Liquidity ratios measure a company's ability to meet its long-term debt obligations.
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The cash ratio measures a company's ability to pay its debts over the next 6 months.
The cash ratio measures a company's ability to pay its debts over the next 6 months.
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A debt ratio of 1 means that total liabilities are half of total assets.
A debt ratio of 1 means that total liabilities are half of total assets.
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The debt ratio is a type of profitability ratio.
The debt ratio is a type of profitability ratio.
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A higher debt ratio is generally more favorable than a lower debt ratio.
A higher debt ratio is generally more favorable than a lower debt ratio.
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The debt ratio is calculated by dividing total assets by total liabilities.
The debt ratio is calculated by dividing total assets by total liabilities.
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Financial leverage is also known as 'trading on equity'.
Financial leverage is also known as 'trading on equity'.
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The times interest earned ratio is calculated by dividing earnings before income and taxes by interest expense.
The times interest earned ratio is calculated by dividing earnings before income and taxes by interest expense.
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A debt ratio of 0.5 is considered highly leveraged.
A debt ratio of 0.5 is considered highly leveraged.
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The debt to equity ratio is the same as the debt ratio.
The debt to equity ratio is the same as the debt ratio.
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A high inventory turnover indicates poor inventory management.
A high inventory turnover indicates poor inventory management.
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A low accounts receivable turnover indicates that a company is efficient in collecting its credit sales.
A low accounts receivable turnover indicates that a company is efficient in collecting its credit sales.
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A company with a higher total asset turnover ratio is using its assets inefficiently.
A company with a higher total asset turnover ratio is using its assets inefficiently.
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The average collection period measures the average number of days between the date a credit sale is made and the date payment is received from the credit sale.
The average collection period measures the average number of days between the date a credit sale is made and the date payment is received from the credit sale.
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Financial leverage ratios measure the ability of a company to settle its maturing liabilities including the interest.
Financial leverage ratios measure the ability of a company to settle its maturing liabilities including the interest.
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Financial leverage refers to the use of equity to acquire additional assets.
Financial leverage refers to the use of equity to acquire additional assets.
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A debt ratio of 1.5 implies a company has more assets than liabilities.
A debt ratio of 1.5 implies a company has more assets than liabilities.
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A company with a debt ratio of 0.5 has more liabilities than assets.
A company with a debt ratio of 0.5 has more liabilities than assets.
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In a company with a debt ratio of 1, investors and creditors have an equal stake in the business assets.
In a company with a debt ratio of 1, investors and creditors have an equal stake in the business assets.
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A debt to equity ratio of 0.25 implies a more risky business to creditors and investors.
A debt to equity ratio of 0.25 implies a more risky business to creditors and investors.
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A company with a debt ratio of 0.5 is considered highly leveraged.
A company with a debt ratio of 0.5 is considered highly leveraged.
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A company with a debt to equity ratio of 0.5 has $2 of equity for every $1 of liabilities.
A company with a debt to equity ratio of 0.5 has $2 of equity for every $1 of liabilities.
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A higher debt ratio implies a company with lower overall debt.
A higher debt ratio implies a company with lower overall debt.
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A company with a debt to equity ratio of 1 has $1 of equity for every $1 of liabilities.
A company with a debt to equity ratio of 1 has $1 of equity for every $1 of liabilities.
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The Times Interest Earned ratio is calculated by dividing the total liabilities by the interest expense.
The Times Interest Earned ratio is calculated by dividing the total liabilities by the interest expense.
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A higher Times Interest Earned ratio indicates a higher credit risk.
A higher Times Interest Earned ratio indicates a higher credit risk.
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Market ratios are based solely on information contained in the firm's financial statements.
Market ratios are based solely on information contained in the firm's financial statements.
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A ratio of 4 in the Times Interest Earned means the company's income is 4 times lower than its interest expense.
A ratio of 4 in the Times Interest Earned means the company's income is 4 times lower than its interest expense.
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The Debt to Equity Ratio is a type of market ratio.
The Debt to Equity Ratio is a type of market ratio.
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Creditors would prefer a company with a lower Times Interest Earned ratio.
Creditors would prefer a company with a lower Times Interest Earned ratio.
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The Times Interest Earned ratio is expressed as a percentage.
The Times Interest Earned ratio is expressed as a percentage.
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Market ratios are not closely watched by those considering security purchases.
Market ratios are not closely watched by those considering security purchases.
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Study Notes
Financial Leverage/Solvency Ratios
- Financial leverage is also known as "trading on equity."
- Debt ratio = Total Liabilities / Total Assets
- A lower debt ratio implies a more stable business with lower overall debt.
- A debt ratio of 1 means total liabilities equal total assets, making the company highly leveraged.
- Debt to equity ratio = Total Liabilities / Common Shareholder's Equity
- A lower debt to equity ratio implies a more financially stable business.
- Times interest earned = Earnings Before Income and Taxes / Interest Expense
- A higher times interest earned ratio indicates a company can afford to pay its interest payments.
Liquidity Ratios
- Liquidity ratios measure a company's ability to meet its short-term debt obligations.
- Current ratio = Current Assets / Current Liabilities
- A higher current ratio indicates a company is more liquid.
- Quick ratio (acid-test ratio) = (Current Assets + Marketable Securities + Accounts Receivable) / Current Liabilities
- Cash ratio = Cash / Current Liabilities
- Accounts receivable turnover = Total Sales / Average Accounts Receivable
- A higher accounts receivable turnover indicates efficient collections.
- Average collection period = Average Accounts Receivable / (Total Sales / 365)
- Total asset turnover = Total Sales / Total Assets
- A higher total asset turnover indicates efficient use of assets.
Market Ratios
- Market ratios are based on information not contained in a firm's financial statements.
- Market ratios are used to evaluate securities for potential purchases.
- These ratios are closely watched by those considering security purchases.
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Description
This quiz covers financial leverage, also known as 'trading on equity', and solvency ratios, including debt ratio and debt to equity ratio. Test your understanding of these financial concepts!
