Analyze Financial Statements Using Ratios
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CPA Business Analysis and Reporting (BAR) › Analyze Financial Statements Using Ratios
The current ratio is calculated as which of the following?
Current assets divided by current liabilities
Current assets minus inventory divided by current liabilities
Current liabilities divided by current assets
Cash and cash equivalents divided by current liabilities
Explanation
The current ratio = Current assets / Current liabilities. It measures the extent to which current assets cover current liabilities. Option B describes the quick ratio, which excludes inventory to measure more immediate liquidity. Option C describes the cash ratio, the most conservative liquidity measure. Option D inverts the formula, producing a ratio below 1.0 for companies in good financial standing.
Stonewall Corp. has current assets of $480,000 and current liabilities of $160,000. What is the current ratio?
0.33
2.40
3.00
4.80
Explanation
Current ratio = Current assets / Current liabilities = $480,000 / $160,000 = 3.00. Option A inverts the formula, dividing current liabilities by current assets. Option C results from using an incorrect current liabilities figure. Option D doubles the correct result through an arithmetic error.
Stonewall Corp. has current assets of $480,000 including inventory of $120,000 and prepaid expenses of $15,000. Current liabilities are $160,000. What is the quick ratio?
1.88
2.16
2.53
3.00
Explanation
Quick ratio = (Current assets - Inventory - Prepaid expenses) / Current liabilities = ($480,000 - $120,000 - $15,000) / $160,000 = $345,000 / $160,000 = 2.16. The quick ratio excludes inventory and prepaids because these assets cannot be quickly converted to cash to meet obligations. Option A is the current ratio, which includes all current assets. Option B excludes only inventory but retains prepaid expenses. Option D excludes inventory and applies an incorrect numerator adjustment.
Thornberry Industries reports net income of $180,000 and total assets of $2,400,000 (assume this equals average total assets). What is the return on assets (ROA)?
7.5%
8.75%
12.5%
20.0%
Explanation
ROA = Net income / Average total assets = $180,000 / $2,400,000 = 7.5%. ROA measures how efficiently the company generates profit from its asset base. Option B adds back a portion of interest expense to net income before dividing. Option C divides net income by equity instead of total assets. Option D divides net income by a fraction of total assets.
Two companies in the same industry have identical asset turnover ratios. Company X has a net profit margin of 18% and Company Y has a net profit margin of 6%. Assuming the equity multiplier is the same for both, which DuPont conclusion is most accurate?
Company Y has higher ROE because it generates more revenue per dollar of assets
Company X has higher ROE than Company Y, given identical asset turnover and equity multiplier
Company X has higher operating efficiency because it earns a higher margin on each revenue dollar
Both companies have the same ROE because asset turnover is identical
Explanation
DuPont ROE = Net margin x Asset turnover x Equity multiplier. With identical asset turnover and equity multiplier, ROE varies directly with net profit margin. Company X's 18% margin produces ROE three times higher than Company Y's 6% margin. Option A incorrectly attributes revenue efficiency to Company Y. Option B ignores the margin component of the DuPont formula. Option C is directionally correct about Company X's margin advantage but does not directly answer the DuPont ROE comparison.
Ridgeline Corp. reports net sales of $3,600,000 and average total assets of $1,800,000. What is the asset turnover ratio?
0.5x
3.0x
1.2x
2.0x
Explanation
Asset turnover = Net sales / Average total assets = $3,600,000 / $1,800,000 = 2.0x. This means the company generates $2.00 of revenue for every $1.00 of assets employed. Option B results from dividing by an incorrect asset figure. Option C inverts the formula. Option D divides net sales by a fraction of average total assets.
Harborview Inc. reports net credit sales of $1,800,000 and average accounts receivable of $150,000. What is the days sales outstanding (DSO)?
30.4 days
12.0 days
45.5 days
8.3 days
Explanation
Receivables turnover = Net credit sales / Average AR = $1,800,000 / $150,000 = 12.0x. DSO = 365 / 12.0 = 30.4 days. DSO measures the average number of days it takes to collect receivables. Option A reports the receivables turnover ratio, not DSO. Option B results from dividing 365 by an incorrect turnover figure. Option C divides average AR by daily sales using an incorrect method.
Clearfield Manufacturing reports cost of goods sold of $2,400,000 and average inventory of $400,000. What is the inventory days on hand?
60.8 days
73.0 days
6.0 days
45.6 days
Explanation
Inventory turnover = COGS / Average inventory = $2,400,000 / $400,000 = 6.0x. Days on hand = 365 / 6.0 = 60.8 days. Option A reports the turnover ratio rather than days. Option C results from dividing 365 by an incorrect turnover of 8.0x. Option D results from dividing 365 by a turnover of 5.0x.
Company A has ROE of 22% from a 5% net margin, 2.0x asset turnover, and 2.2x equity multiplier. Company B also has ROE of 22% from a 10% net margin, 1.1x asset turnover, and 2.0x equity multiplier. Which statement best characterizes the difference between the two companies?
Company B is riskier because its higher margin may indicate pricing power that competitors will erode
Company A relies more on financial leverage to achieve its ROE, while Company B relies more on profitability
The companies are strategically identical because both produce the same ROE
Company A has a superior business model because it generates more asset turns per dollar invested
Explanation
Company A reaches 22% ROE using a lower margin (5%) but compensates with higher asset turnover (2.0x) and higher financial leverage (2.2x equity multiplier). Company B uses a higher margin (10%) and lower leverage (2.0x) but generates fewer revenue dollars per asset dollar (1.1x). The key structural difference is that Company A carries more financial risk through leverage, while Company B generates returns primarily through profitability. Option A ignores the structural differences in how the same ROE is achieved. Option B focuses only on asset turnover without the complete picture. Option C misidentifies higher margin as a risk factor rather than a quality indicator.
A company reports: net income $240,000, beginning total assets $2,000,000, ending total assets $2,400,000. What is the return on assets (ROA) using average total assets?
9.5%
10.9%
12.0%
16.9%
Explanation
Average total assets = ($2,000,000 + $2,400,000) / 2 = $2,200,000. ROA = $240,000 / $2,200,000 = 10.9%. Option B divides net income by ending assets only rather than average assets. Option C divides by a midpoint calculation using an incorrect formula. Option D divides net income by a figure significantly below average total assets.