Multiple Choice
Which of the following is the most widely accepted and insightful method of valuation in financial analysis?
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14. Financial Statement Analysis
Introduction to Ratios
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Which of the following ratios is primarily used to measure a company's liquidity?
A
Debt-to-Equity Ratio
B
Current Ratio
C
Return on Equity (ROE)
D
Inventory Turnover Ratio
Verified step by step guidance1
Understand the concept of liquidity: Liquidity refers to a company's ability to meet its short-term obligations using its current assets. Ratios that measure liquidity focus on the relationship between current assets and current liabilities.
Review the Current Ratio formula: The Current Ratio is calculated as \( \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} \). This ratio indicates whether a company has enough resources to cover its short-term debts.
Compare the given ratios: Debt-to-Equity Ratio measures financial leverage, Return on Equity (ROE) measures profitability, and Inventory Turnover Ratio measures operational efficiency. None of these directly assess liquidity like the Current Ratio does.
Identify why the Current Ratio is the correct answer: The Current Ratio specifically evaluates a company's ability to pay off its short-term liabilities using its short-term assets, making it the primary measure of liquidity.
Conclude that the Current Ratio is the correct choice for measuring liquidity, as it directly addresses the relationship between current assets and current liabilities.
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