The correct choice of this multiple choice question is (C), as ratio analysis
is used to express the relationship between items or accounts of Financial
Statements. For example, Current Ratio is used to show the relationship between
Current
Assets and Current
Liabilities. If the company has more current assets than its current liabilities
then its business can easily meet daily expenses and pay short-term obligations
to run the daily operations of the business and may earn revenue for the
period. If the current ratio is more than 1, then the business can easily meet
current liabilities. If it is less than 1, then the business is unable to meet
its current liabilities with current assets. This is critical for the continuity
and survival of the business as it may fail to carry on the business i.e., unable
to pay its short-term debts necessary to run the business and as a result the
business operations are stopped and business suffered the losses. If the current
ratio is equal to 1, then the business is just able to meet its short-term
obligation with its current assets.
In case of Quick
Ratio, the relationship between quick assets and current liabilities are
shown. Quick assets include cash and cash equivalents and accounts receivable
which are convertible into cash very quickly. The ideal ratio is greater than
and not good if it is less than 1.
Profitability Ratio shows the relationship between
revenues and expenses incurred to earn profits for the company’s business. It
shows how much the company earn profits after matching revenues and expenses
for the current accounting period. Important profitability ratios include Gross
Profit Ratio and Net Profit Ratio. Gross profit ratio shows the
relationship between Gross profit and total net sales i.e., GP = Gross Profit /
Total Net Sales X 100. Net profit ratio shows the relationship between net
profit and total revenue i.e., Net Profit / Total Revenue X 100.
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