Question

1. Making Moves has the following data available.
Sales                                              $800 000
Selling expenses                                160 000
Profit                                                  320 000
Using vertical analysis, express selling expenses as a percentage of the base amount.

a. 60%
b. 50%
c. 20%
d. 15%

2. How many of these ratios measure the adequacy of profits?
Profit before interest and finance costs/ finance costs
Profit compared to total assets
Profit compared to sales
Profit compared to equity

a. 1
b. 2
c. 3
d. 4

3. Financial ratios are used for all of the following purposes except:

a. by taxation authorities to determine the amount of tax payable.
b. by shareholders to assess profitability.
c. by creditors to monitor liquidity.
d. by management for planning and control.

4. If an entity is able to earn more on borrowings than the cost of those borrowings the return on equity will:

a. increase.
b. decrease.
c. be unchanged.
d. vary.

5. Profit before finance costs is used in calculating return on total assets because:

a. the efficient use of resources should be examined independently of the method of financing.
b. it is simpler to calculate than profit after deducting finance costs.
c. interest rates are hard to predict.
d. interest is a tax deduction for a company.

Answer 1

1. Answer: c. 20%

Selling expenses as a percentage of the base amount = Selling expenses/Sales = $160000/$800000 = 20%

2. Answer: d. 4

The times interest earned ratio, return on total assets ratio, net profit ratio, and return on equity ratio, all measure the adequacy of profits. Thus, all the 4 ratios given measure the adequacy of profits and hence option d. is the correct answer.

3. Answer: a. by taxation authorities to determine the amount of tax payable.

Financial ratios are used by shareholders to assess profitability, by creditors to monitor the liquidity, and by management for purposes of planning and control. However, financial ratios are not used to determine the liability for tax payable. Hence, option a. is the correct answer.

4. Answer: a. increase

If the entity is able to earn more on borrowings than the cost of those borrowings, the net income and thus the return on equity will increase. Hence, option a. is the correct answer.

5. Answer: a. the efficient use of resources should be examined independently of the method of financing.

Finance costs will vary depending upon the sources of finance used by an entity. Hence, while computing the return on total assets, the operating income or profit before finance costs is used. Thus, option a. is the correct answer.