Multiple Choice
A tool used to evaluate individual financial statement items or a group of items is called:
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14. Financial Statement Analysis
Introduction to Ratios
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Which of the following is correctly categorized as a liquidity ratio?
A
Gross Profit Margin
B
Debt-to-Equity Ratio
C
Return on Assets (ROA)
D
Current Ratio
Verified step by step guidance1
Understand the concept of liquidity ratios: Liquidity ratios measure a company's ability to meet its short-term obligations using its current assets. These ratios assess the financial health of a company in the short term.
Review the formula for the Current Ratio: The Current Ratio is calculated as \( \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} \). This ratio indicates how well a company can cover its short-term liabilities with its short-term assets.
Analyze the other options: Gross Profit Margin, Debt-to-Equity Ratio, and Return on Assets (ROA) are not liquidity ratios. Gross Profit Margin measures profitability, Debt-to-Equity Ratio measures leverage, and ROA measures efficiency in using assets to generate profit.
Identify why the Current Ratio is the correct answer: The Current Ratio directly evaluates liquidity by comparing current assets to current liabilities, making it a liquidity ratio.
Conclude that the Current Ratio is correctly categorized as a liquidity ratio because it aligns with the definition and purpose of liquidity ratios.
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