Answers to Final Exams – Short Courses located at

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Course 1 – Evaluating Financial Performance

1. Which ratio is best used for measuring how well management did in managing the funds
provided by shareholders?

a. Profit Margin

b. Debt to Equity

c. Return on Equity

d. Inventory Turnover

Answer = c: Shareholders are interested in the return a business generates on the money the
shareholder has invested. Therefore, answer c – Return on Equity is correct. Shareholders tend to
focus on long term returns vs. managers who focus on profitability. Answer a – Profit Margin would
be more applicable to Managers. Financial Managers and people interested in assessing risk would
be interested in b – Debt to Equity. Mangers, primarily interested in inventory management, would be
interested in d – Inventory Turnover.

2. If sales are $ 600,000 and assets are $ 400,000, then asset turnover is:

a. .67

b. 1.50

c. 2.00

d. 3.50

Answer = b: The British often refer to sales as turnover since the ultimate reason a business invests
in assets is to turn over the asset dollar into a sales dollar. If we divide sales of $ 600,000 by $
400,000 we get 1.5 – answer is thus b. Average assets is often used in the denominator of the ratio.
This tells us for every $ 1.00 we invested into assets, we were able to turn this into $ 1.50 of sales.

3. An extremely high current ratio implies:

a. Management is not investing idle assets productively.

b. Current assets have been depleted and the company is insolvent.

c. Total assets are earning a very low rate of return.

d. Current liabilities are higher than current assets.

Answer = a: A high current ratio may imply that the company is carrying a lot of current assets on the
books and these assets might be better utilized if the company invested or converted these assets
into long-term investments. Generally, a business generates a return on its long-term assets and not
its liquid or current assets such as cash, accounts receivable, or inventory. These types of assets are
sitting around – idle. They don’t produce or generate sales or service customers like your long-term
investments in technology would. You gain little by holding idle assets (including non-productive fixed
assets) and you tend to gain much more by investing into longer term investments that provide
solutions to your customers, make your employees more productive, etc.

4. If we have cash of $ 1,500, accounts receivables of $ 25,500 and current liabilities of $ 30,000,
our quick or acid test ratio would be:

a. 1.88

b. 1.33

c. 1.11

d. .90

Answer = d: If you add up your highly liquid assets ($ 1,500) of cash and accounts receivable ($
25,500), you have total liquid assets of $ 27,000. Now divide this by the total current liabilities of $
30,000 = .90. For every $ 1.00 of current liabilities, we have $ .90 of liquid assets to cover these
liabilities.

5. The number of times we convert receivables into cash during the year is measured by:

a. Capital Turnover

b. Asset Turnover

c. Accounts Receivable Turnover

d. Return on Assets

Answer = c: The Accounts Receivable Turnover ratio measures the number of times you turn
receivables over into cash. It is calculated by dividing your credit sales by the average receivable
balance for the period. For example, if you had credit sales for the year of $ 100,000 and your
average receivable balance during the year was $ 10,000, then you have a receivable turnover of 10.

6. If our cost of sales are $ 120,000 and our average inventory balance is $ 90,000, then our
inventory turnover rate is:

a. .50

b. .75

c. 1.00

d. 1.33