Short Questions and Answers of Ratio Analysis

 Short Questions and Answers of Ratio Analysis

Short Questions and Answers of Ratio Analysis

1. What do you mean by ratio analysis?

Answer-: Ratio analysis is the most widely used technique for interpreting and comparing financial reports. It analyses financial data from the firm’s Profit and Loss Account and Balance Sheet.

2. Why is ratio analysis necessary?

Answer-: Ratio Analysis is necessary for the following reasons,

(i) To allow comparisons to be made which assist in predicting the future.

(ii) To investigate the reasons for the changes.

(iii) To construct a simple explanation of a complicated financial statement by its expression in one figure.

(iv) To permit the charting of a firm’s history and the evaluation of its present position.

3. State two advantages of ratio analysis.

Answer-: The two advantages of ratio analysis are the following

(i) It is used as an aid to simplify the comprehension of financial statements.

(ii) It is used as an aid to analysis and interpretation of financial statements.

4. State two limitations of ratio analysis.

Answer-: Two limitations of ratio analysis are as follows:

(i) Financial statement suffers from a number of limitations. When ratios are constructed from those financial statements, ratios suffer from the inherent weakness of the accounting system itself.

(ii) By using ratios, forecast of future of a business may not be prove correct. This is because, ratios are all based on past happenings and not future probabilities. They are subject to changes in the future.

5. Who are users of ratio analysis?

Answer-: Users of ratios can be classified into two groups – internal and external. Internal group consists of directors, shareholders, partners, managers, etc. External group consist of investors, lenders, suppliers, employees, labour union, customers, etc.

6.  Give the examples of Current Assets.

Answer-:  Examples of Current Assets are:

                  1. Cash in Hand

                  2. Cash at Bank

                  3. Cash Equivalents

                  4. Short-term Investment

                  5. Tread Debtors

                  6. Bills Receivables

                  7. Accrued Income

                  8. Prepaid Expenses

                  9. Stock in Tread

                10. Advance Tax

7.  Give the Examples of Current Liabilities.

Answer-:  Examples of Current Liabilities are

                  1.  Trade Creditors

                  2.  Bills Payable

                  3.  Liability for Taxes

                  4.  Outstanding Expenses

                  5.  Income received in advance

                  6.  Provision for Taxation

                  7.  Proposed Dividend

                  8.  Short-term Bank Loan (e.g., cash credit, overdraft etc.)

                  9.  Current Portion of Long-term Loan.

8.  What is Quick Ratio?

Answer-: The quick ratio is the relationship between quick assets and quick liabilities. Quick assets are all those assets which in ordinary course of business will be converted into cash. Therefore, quick assets are current assets less stock and prepaid expenses, i.e., cash, bank, debtors and readily realisable marketable securities.

9.  What is Current Ratio?

Answer-: Current Ratio is the relationship between current assets and current liabilities. It is quoted as a single figure (not percentage). Current assets are cash, cash equivalents and other assets which are expected to be realised in cash or sold or consumed within one year (or the normal operating cycle of the company if it is greater than one year). On the other hand, current liabilities are the obligations of the business which are repayable within a relatively short period of time, usually one year.

10.  Why is stock deducted from current assets at the time of calculating quick ratio?

Answer-: The quick ratio does not take into consideration stock because they are normally sold on credit (converted into a debtor) and then the debtor must be collected before cash is paid.

            Another reason is that a firm must maintain a minimum level of stock at point of time.

11. What is interest coverage ratio?

Answer-: The interest coverage ratio is the relationship between EBIT (Earning Before Interest and Tax) and interest payable. It indicates the capacity of the organisation to pay interest to lender regularly.

EBIT is the profit after changing all expenses including depreciation but before changing interest and income tax.

12. What is debtors turnover ratio?

Answer-: Debtors turnover ratio is the ratio between the credit sales (if the information is regard to credit sales is not available, total sales may be taken in the place of credit sales) and average debtors plus average bills receivable. The ratio indicates the number of time per year that the average balance of debtors are collected.

13. What is stock turnover ratio?

Answer-: Stock turnover ratio is the ratio between the stock of finished goods and the cost of goods sold. The stock turnover ratio measures how quickly stock is sold, i.e., the number of times of a company’s stock turnover ratio during a year.

14. What is operating profit ratio?

Answer-: Operating profit ratio is the relationship between operating profit and sales. Operating profit is calculated after deducting operating expenses from gross profit. N non operating profits such as dividend / interest from investment are taken into consideration.

15. What is operating ratio?

Answer-: Operating ratio is the ratio between ‘cost of goods sold plus operating expenses per rupee of sales. It is expensed as a percentage of sales.

16. What is the significance of debt-equity ratio?

Answer-: Debt equity ratio measures the contribution of lenders relative to the contribution of owners. Debt equity ratio is also used as a measure of debt exposure, i.e., the extent to which the firm has been financed by debt.

17. How to debt-equity ratio can be improved?

Answer-: Debt equity ratio can be improved in the following manner:

(1) By increasing share capital

(2) By paying long-term debts

18. What is creditors turnover ratio?

Answer-: Creditors turnover ratio is the ratio between the credit purchase (if the information in regard to credit purchase is not available, total purchase may be taken in place of credit purchase) and average creditors plus average bills payable. This ratio indicates the numbers of times per year that the average balances of creditors are paid.

19. What is proprietary ratio?

Answer-: Proprietary ratio is the ratio between shareholder’s funds and total assets. This ratio shows the proportion of total assets of a business financed by shareholders’ fund.

20. State the significance of high debt-equity ratio.

Answer-: High debt-equity ratio is not good for the organisation particularly when the demand for the product is not good. Majority portion of the revenue will be required for paying the interest on loan. The organisation will also face problem for getting future loan.