8.2 Interpretation of financial statements

• The balance sheet shows the financial position of a business at a specific point in time.


  True
• What does the gross profit margin measure?

  Profitability of core operations
• The acid test ratio excludes inventory from current assets to provide a more conservative measure of liquidity.
• The current ratio is calculated by dividing current assets by current liabilities
• The debt-to-equity ratio is calculated by dividing total liabilities by total equity
• What does the interest coverage ratio measure?

  Ability to pay interest
• An interest coverage ratio of 5.0 suggests the business can comfortably cover its interest payments.


  True
• What does a gross profit margin trend indicate?

  Profitability of core operations
• The balance sheet shows a business's financial position at a specific point in time.
• What does a cash flow statement track?

  Cash inflows and outflows
• What does the gross profit margin measure?

  Profitability of core operations
• What does the current ratio measure?

  Short-term debt ability
• An acid test ratio of 1.6 indicates strong immediate liquidity.


  True
• What does the current ratio measure?

  Short-term liabilities with assets
• The acid test ratio provides a more conservative measure of liquidity than the current ratio.

  True
• The balance sheet, income statement, and cash flow statement provide a comprehensive view of a business's financial health.

  True
• What does the current ratio measure?

  Ability to cover short-term debts
• What does the current ratio measure?

  Short-term debt ability
• A current ratio of 2.0 indicates strong liquidity.

  True
• The acid test ratio is also known as the quick ratio.
• What does the debt-to-equity ratio measure?

  Financial leverage and risk
• Order the following financial trends from most profitable to least profitable:

  1️⃣ Gross Profit Margin increasing

  2️⃣ Net Profit Margin increasing

  3️⃣ Current Ratio strengthening

  4️⃣ Debt-to-Equity Ratio decreasing
• Match the financial statement with its purpose:

  Balance Sheet ↔️ Financial position at a point in time

  Income Statement ↔️ Profitability over a period

  Cash Flow Statement ↔️ Cash inflows and outflows
• What does an income statement measure?

  Profitability over a period
• Together, the three key financial statements provide a comprehensive view of a business's financial health.

  True
• What does the net profit margin measure?

  Overall profitability
• A gross profit margin of 40% indicates that 40% of revenue remains after deducting the cost of goods sold.


  True
• The acid test ratio is a more conservative measure of short-term liquidity.
• What does the acid test ratio of 1.6 indicate for a business?

  Strong immediate liquidity
• An interest coverage ratio of 5.0 suggests the business can comfortably cover its interest from operating income.
• Benchmarking liquidity ratios such as the current ratio compares short-term solvency to industry peers.
• What recommendation is given for a business with a low net profit margin compared to industry peers?

  Reduce overhead expenses
• The interest coverage ratio measures a business's ability to cover its interest expense.
• What is the purpose of trend analysis in financial statements?

  Track financial metric changes
• Match the ratio with its benchmarking insight:

  Gross Profit Margin ↔️ Competitive advantage in operations

  Debt-to-Equity Ratio ↔️ Financial leverage compared to industry

  Interest Coverage Ratio ↔️ Ability to cover interest payments
• What are the three key financial statements?

  Balance sheet, income statement, cash flow statement
• The cash flow statement shows the cash inflows and outflows
• What does a high gross profit margin indicate about a business?

  Efficient core operations
• A debt-to-equity ratio of 1.6 indicates high financial leverage.

  True
• The interest coverage ratio is calculated by dividing EBIT by interest expense.