UNIT 2B

What are the main categories of financial ratios?

Profitability, liquidity, solvency, cash flow, and investment ratios.

What does the return on equity (ROE) ratio indicate?

The return generated on the total equity invested in the entity.

What is the significance of the DuPont analysis?

It breaks down return ratios to understand the factors contributing to overall returns.

What does a current ratio of less than 1 indicate?

There are insufficient current assets to cover current liabilities.

How does financial gearing affect shareholders' returns?

If managed well, it can increase returns; if not, it can decrease returns.

What is the primary purpose of liquidity ratios?

To evaluate an entity's ability to meet short-term obligations.

What does the cash flow to revenue ratio measure?

The portion of revenue converted into cash retained from operating activities.

What does a negative return on equity (ROE) signify?

The entity is earning less on its equity than its cost of capital.

Why is it important to compare ratios over time?

To identify trends and determine whether the entity's financial situation is improving or declining.

What does a debt-to-assets ratio of 0.46 imply about a company?

46% of the total assets are financed with debt capital, suggesting acceptable solvency.

What is a key indicator of profitability for shareholders?

Earnings per share (EPS).

What effect does an increase in return on assets (ROA) have on profitability?

It indicates that the entity is utilizing its assets more efficiently to generate revenue.

What are solvency ratios used for?

To assess an entity's ability to meet its long-term debts and financial obligations.

What does the quick ratio measure?

The ability to meet short-term liabilities with the most liquid assets, excluding inventory.

Why is cash flow important to investors?

It indicates the actual cash generated by operations, reflecting the company's liquidity.

What does the price-to-earnings (P/E) ratio indicate?

The market’s valuation of a company’s earnings, reflecting investor expectations.

What is meant by financial leverage?

The use of borrowed funds to increase the potential return on investment.

What is a high current ratio typically indicating?

A strong liquidity position, suggesting the ability to pay off short-term liabilities.

What can cause a decline in the return on equity?

Increased debt levels or reduced net income affecting profitability.

What is the significance of gross profit margin?

It measures the efficiency of a company in generating profit from sales.

What does a low debt-to-equity ratio suggest?

The company is less reliant on borrowed funds to finance its operations.

How can financial ratios assist in benchmarking?

They provide a basis to compare a company's performance against industry standards or peers.