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Theme 3: Business Decisions and Strategy
3.5 Assessing Competitiveness
3.5.2 Ratio Analysis
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Ratio Analysis is a technique used to evaluate a company's financial
performance
Ratio Analysis involves calculating ratios to compare key
financial
figures.
Match the type of ratio with its purpose:
Profitability Ratios ↔️ Measures profitability
Liquidity Ratios ↔️ Measures short-term debt coverage
Efficiency Ratios ↔️ Measures asset utilization
Order the steps involved in using Ratio Analysis to evaluate a company's financial health:
1️⃣ Identify the financial ratios
2️⃣ Calculate the ratios using financial data
3️⃣ Interpret the ratio results
What do Profitability Ratios measure?
Company's ability to generate profits
Liquidity Ratios assess the company's short-term financial
health
How do Efficiency Ratios evaluate a company's performance?
By measuring asset utilization
The Gross Profit Margin measures profitability after accounting for the
cost of goods sold
.
The Net Profit Margin shows the profit left after all expenses are
deducted
What does the Return on Capital Employed (ROCE) indicate?
How well capital generates earnings
A Current Ratio
above 1
suggests good liquidity.
The Quick Ratio provides a more conservative measure of liquidity by excluding
inventory
What does Ratio Analysis help stakeholders understand?
Financial strengths and weaknesses
The Current Ratio measures a company's ability to meet
short-term
obligations.
A Current Ratio of 2 indicates the company can cover its short-term debts
twice
What does the Gross Profit Margin measure?
Profitability after cost of goods sold
The Net Profit Margin shows the profit remaining after all
expenses
are deducted from revenue.
What does the Return on Capital Employed (ROCE) indicate about a company?
Efficiency in using capital
A Current Ratio above
1
suggests good liquidity.
The Quick Ratio excludes
inventory
What does the Asset Turnover Ratio measure?
Efficiency in using assets
A higher Inventory Turnover Ratio suggests
faster
inventory turnover.
What does the Days Sales Outstanding (DSO) represent?
Time to collect payment
The Debt-to-Equity Ratio measures debt relative to
equity
What does the Debt-to-Capital Ratio measure?
Debt in total capital
What does a higher debt-to-equity ratio suggest about a company's financial risk?
More financial risk
The debt-to-capital ratio measures the proportion of debt in a company's total
capital
Arrange the steps involved in ratio analysis to evaluate a company's financial performance.
1️⃣ Calculate ratios
2️⃣ Identify strengths and weaknesses
3️⃣ Make informed decisions
Ratio analysis involves comparing key financial figures to understand a company's profitability, liquidity,
efficiency
, and solvency.
What are the three main types of financial ratios used in ratio analysis?
Profitability, liquidity, efficiency
Profitability ratios measure a company's ability to generate profits relative to its
revenue
What do liquidity ratios assess about a company?
Short-term obligations
Efficiency ratios evaluate how well a company utilizes its assets to generate
revenue
.
What does the gross profit margin measure?
Profitability after cost of goods sold
The net profit margin shows the profit left after all
expenses
Return on capital employed
indicates how well a company uses its capital to generate earnings.
What do liquidity ratios measure about a company?
Ability to meet short-term obligations
A current ratio above 1 suggests good
liquidity
Match the liquidity ratio with its formula:
Current Ratio ↔️
Current Assets
Current Liabilities
\frac{\text{Current Assets}}{\text{Current Liabilities}}
Current Liabilities
Current Assets
Quick Ratio ↔️
Current Assets
−
Inventory
Current Liabilities
\frac{\text{Current Assets} - \text{Inventory}}{\text{Current Liabilities}}
Current Liabilities
Current Assets
−
Inventory
Both the current ratio and the quick ratio indicate good liquidity when
above 1
.
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