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Financial Ratios and Ratio Analysis MCQs

When interpreting financial statements, it is important to ascertain who are the users of accounts and what information they need.

Financial Ratios and Ratio Analysis MCQs

When interpreting financial statements, it is important to ascertain who are the users of accounts and what information they need. Here on MCQs.club we have prepared easy and useful Multiple-Choice Questions (MCQs) on ratio analysis and financial ratios that fully cover current ratio, debt to equity ratio, interest coverage ratio, profitability ratio, accounts receivable/payable turnover, financial leverage ratio, working capital turnover ratio. We have prepared mcqs on different types of financial ratios, including the most important financial ratios with examples, uses and purpose of financial ratios. Theses are a complete list of accounting ratios. These common ratios for financial analysis are useful for competitive exams, professional exams, accountancy exams and business management exams.

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When interpreting financial statements, it is important to ascertain who are the users of accounts and what information they need.
1. True
2. False
Users of financial statements include:
1. shareholders and potential investors
2. suppliers and lenders
3. financial journalists and commentators
4. All of the above
Gross profit margin – This is the margin that the company makes on its sales, and would be expected to remain reasonably constant.
1. True
2. False
The Gross profit margin ratio is affected by only a small number of variables, a change may be traced to a change in:
1. selling prices
2. sales mix
3. purchase cost and production cost
4. All of the above
Any changes in operating profit margin should be considered further:
1. Are they in line with changes in gross profit margin?
2. Are they in line with changes in sales revenue?
3. As many costs are fixed, they need not necessarily increase/decrease with a change in revenue.
4. Look for individual cost categories that have increased/decreased significantly.
5. All of the above
For calculating the ROCE ration profit is measured as:
1. operating (trading) profit
2. the PBIT, i.e. the profit before taking account of any returns paid to the providers of long-term finance.
3. Both A&B
4. None
For ROCE ratio the ‘Capital employed’ is measured as equity, plus interest-bearing finance, i.e. the long-term finance supporting the business.
1. True
2. False

ROCE for the current year should be compared to:
1. the prior year ROCE
2. a target ROCE
3. the cost of borrowing
4. other companies’ ROCE in the same industry.
5. All of the above
The Net Asset Turnover ratio measures management’s efficiency in generating revenue from the net assets at its disposal – the higher, the more efficient.
1. True
2. False
Net Asset Turnover ratio can be further subdivided into:
1. noncurrent asset turnover (by making noncurrent assets the denominator)
2. working capital turnover (by making net current assets the denominator)
3. Both A&B
4. None
A tradeoff may exist between margin and asset turnover. Which of the following is correct?
1. Low-margin businesses (e.g. food retailers) usually have a high asset turnover.
2. Capital-intensive manufacturing industries usually have relatively low asset turnover but higher margins (e.g. electrical equipment manufacturers).
3. Both A&B
4. None
Which of the following strategy will help achieve ROCE?
1. Sell goods at a high profit margin with sales volume remaining low (e.g. designer dress shop).
2. Sell goods at a low profit margin with very high sales volume (e.g. discount clothes store)
3. Both A&B
4. None
The overall working capital is measured using:
1. the current ratio
2. the quick or acid test ratio
3. Both A&B
4. None
The current ratio measures the adequacy of current assets to meet the liabilities as they fall due.
1. True
2. False

While calculating the Current ratio a high or increasing figure may appear safe but should be regarded with suspicion as it may be due to:
1. high levels of inventory and receivables (check working capital management ratios)
2. high cash levels which could be put to better use (e.g. by investing in non-current assets).
3. Both A&B
4. None
Which of the following is correct for the “Current ratio”?
1. The current ratio measures the adequacy of current assets to meet the company’s short-term liabilities.
2. It reflects whether the company is in a position to meet its liabilities as they fall due.
3. A current ratio of 2:1 or higher was regarded as appropriate for most businesses to maintain creditworthiness.
4. All of the above
The current ratio should be looked at in the light of what is normal for the business. For example, supermarkets tend to have low current ratios because:
1. there are few trade receivables
2. there is a high level of trade payables
3. there is usually very tight cash control, to fund investment in developing new sites and improving sites.
4. All of the above
Which of the following is correct for the “Quick ratio”?
1. The quick ratio is also known as the acid test ratio
2. Normal levels for the quick ratio range from 1:1 to 0.7:1
3. Both A&B
4. None
Quick liabilities would usually include:
1. bank overdraft which is repayable on demand
2. trade payables, tax and social security
3. dividends
4. All of the above
An increasing number of days (or a diminishing multiple) implies that inventory is turning over less quickly which is regarded as a bad sign as it may indicate:
1. lack of demand for the goods
2. poor inventory control
3. an increase in costs (storage, obsolescence, insurance, damage)
4. All of the above
For the Receivables collection period ratio, the collection period should be compared with:
1. the stated credit policy
2. previous period figures
3. Both A&B
4. None

Increasing accounts receivables collection period is usually a bad sign suggesting lack of proper credit control which may lead to irrecoverable debts. It may, however, be due to:
1. a deliberate policy to attract more trade, or
2. a major new customer being allowed different terms
3. Both A&B
4. None
The receivables days ratio can be distorted by:
1. using yearend figures which do not represent average receivables
2. factoring of accounts receivables which results in very low trade receivables
3. sales on unusually long credit terms to some customers.
4. All of the above
The Payables payment period ratio is always compared to previous years:
1. A long credit period may be good as it represents a source of free finance.
2. A long credit period may indicate that the company is unable to pay more quickly because of liquidity problems.
3. Both A&B
4. None
If the credit period is long:
1. the company may develop a poor reputation as a slow payer and may not be able to find new suppliers
2. existing suppliers may decide to discontinue supplies
3. the company may be losing out on worthwhile cash discount
4. All of the above
Overtrading arises where a company expands its sales revenue fairly rapidly without securing additional long-term capital adequate for its needs.
1. True
2. False
The symptoms of overtrading are:
1. inventory increasing, possibly more than proportionately to revenue
2. receivables increasing, possibly more than proportionately to revenue
3. cash and liquid assets declining at a fairly alarming rate
4. trade payables increasing rapidly.
5. All of the above
The main points to consider when assessing the longer-term financial position are:
1. Gearing
2. Overtrading
3. Both A&B
4. None

Gearing ratios indicate:
1. the degree of risk attached to the company
2. the sensitivity of earnings and dividends to changes in profitability and activity level.
3. Both A&B
4. None
In highly geared businesses:
1. a large proportion of fixed-return capital is used
2. there is a greater risk of insolvency
3. returns to shareholders will grow proportionately more if profits are growing
4. All of the above
Low-geared businesses:
1. provide scope to increase borrowings when potentially profitable projects are available
2. can usually borrow more easily
3. Both A&B
4. None
The Interest cover ratio indicates the ability of a company to pay interest out of profits generated:
1. low interest cover indicates to shareholders that their dividends are at risk (because most profits are eaten up by interest payments)
2. the company may have difficulty financing its debts if its profits fall
3. interest cover of less than two is usually considered unsatisfactory
4. All of the above
Identify the Profitability ratios:
1. gross profit margin, operating profit margin, ROCE and net asset turnover
2. current ratio, quick ratio, inventory collection period
3. Both A&B
4. None
Identify the Liquidity and working capital ratios:
1. gross profit margin, operating profit margin, ROCE and net asset turnover
2. current ratio, quick ratio, inventory collection period
3. Both A&B
4. None
Which of the following is correct for the “P/E ratio”?
1. It represents the market’s view of the future prospects of the share
2. High P/E suggests that high growth is expected
3. Both A&B
4. None

Which of the following is correct for the “Dividend yield”?
1. can be compared to the yields available on other investment possibilities
2. the lower the dividend yield, the more the market is expecting future growth in the dividend, and vice versa.
3. Both A&B
4. None
The higher the dividend cover, the more likely it is that the current dividend level can be sustained in the future.
1. True
2. False
Ratios are not predictive if they are based on historical information. Which of the following is correct?
1. They ignore future action by management.
2. They can be manipulated by window dressing or creative accounting.
3. They may be distorted by differences in accounting policies.
4. All of the above
Creative accounting –
1. Creative accounting refers to the accounting practices that are designed to mislead the view that the user of financial statements has on a company’s underlying economic performance.
2. Creative accounting is used to increase profits, inflate asset values or understate liabilities.
3. Both A&B
4. None
Window dressing – is a method of carrying out transactions in order to distort the position shown by the financial statements and generally improve the position shown by them.
1. True
2. False

Financial Ratios and Ratio Analysis MCQs

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