Accounting Online Program Accounting Financial Ratios 2 — Questions and Answers
Question 1: A company has net income of $150,000 and average shareholders' equity of $750,000. What is the Return on Equity (ROE)?
- 10%
- 15%
- 20% (Correct answer)
- 25%
Correct answer: 20%
ROE = Net Income / Average Shareholders' Equity = $150,000 / $750,000 = 20%.
Question 2: Which ratio measures how efficiently a company collects its accounts receivable?
- Inventory turnover ratio
- Accounts receivable turnover ratio (Correct answer)
- Asset turnover ratio
- Payables turnover ratio
Correct answer: Accounts receivable turnover ratio
The accounts receivable turnover ratio measures how many times per period a company collects its average accounts receivable balance.
Question 3: If a firm's debt-to-equity ratio is 2.0, what does this indicate?
- The company has twice as much equity as debt
- The company has twice as much debt as equity (Correct answer)
- The company is debt-free
- The company's assets equal its liabilities
Correct answer: The company has twice as much debt as equity
A debt-to-equity ratio of 2.0 means the company has $2 of debt for every $1 of equity.
Question 4: A company reports EBIT of $200,000 and interest expense of $40,000. What is its interest coverage ratio?
- 2.0
- 4.0
- 5.0 (Correct answer)
- 6.0
Correct answer: 5.0
Interest coverage ratio = EBIT / Interest Expense = $200,000 / $40,000 = 5.0.
Question 5: Which profitability ratio is calculated as (Gross Profit / Net Sales) × 100?
- Net profit margin
- Operating profit margin
- Gross profit margin (Correct answer)
- Return on assets
Correct answer: Gross profit margin
The gross profit margin measures the percentage of sales revenue remaining after deducting the cost of goods sold.
Question 6: The Price-to-Earnings (P/E) ratio is best used to evaluate:
- A company's liquidity position
- How much investors pay per dollar of earnings (Correct answer)
- The efficiency of inventory management
- A company's ability to pay dividends
Correct answer: How much investors pay per dollar of earnings
The P/E ratio reflects the market price per share divided by earnings per share, showing investor valuation relative to earnings.
Question 7: Days Sales Outstanding (DSO) of 45 days compared to an industry average of 30 days suggests:
- The company collects receivables faster than peers
- The company may have collection issues or lenient credit terms (Correct answer)
- The company has excellent liquidity
- The company's inventory is moving slowly
Correct answer: The company may have collection issues or lenient credit terms
A higher DSO than the industry average indicates slower collection of receivables, which may signal credit or collection problems.
Accounting Online Program Accounting Financial Ratios 2
A company has net income of $150,000 and average shareholders' equity of $750,000.
What is the Return on Equity (ROE)?