RATIO ANALYSIS
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What is ratio analysis in the context of banking and financial statement interpretation?
Ratio analysis is a quantitative technique used to evaluate the financial performance, liquidity, solvency, and profitability of a firm by computing relationships between two or more financial statement items. It enables comparison across periods and peer institutions.
What is the formula for calculating the Current Ratio?
Current Assets divided by Current Liabilities.
Which financial statements are primarily used to derive ratios in ratio analysis?
The Balance Sheet and the Profit & Loss Account (Income Statement) are the primary sources for computing financial ratios, and in some analyses the Cash Flow Statement is also used.
Which ratio measures a firm's ability to meet short-term obligations without selling inventory?
Quick Ratio or Acid Test Ratio.
What does the Current Ratio measure and what is its standard benchmark?
The Current Ratio measures a firm's ability to meet short-term obligations using current assets; it is computed as Current Assets divided by Current Liabilities. A ratio of 2:1 is generally considered ideal.
What does a Debt-Equity Ratio greater than 2:1 indicate for a borrower?
High financial leverage and greater lender risk.
How is the Quick Ratio (Acid Test Ratio) different from the Current Ratio?
The Quick Ratio excludes inventory and prepaid expenses from current assets, making it a more stringent test of liquidity. It is computed as (Current Assets – Inventory – Prepaid Expenses) divided by Current Liabilities, with 1:1 considered satisfactory.
How is the Net Working Capital ratio defined in financial analysis?
Current Assets minus Current Liabilities equals Net Working Capital.
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