All questions of Accounting Ratios for Commerce Exam

Option (b) is the right answer as both the statements are true but the reason is no way related to the assertion of the given question

Assertion (A): Higher the Gross Profit ratio, good for the business, lower ratio not good for the business.
Reason (R): It reflects the efficiency with which a firm produces its products. A high gross profit ratio indicates that the organization is able to produce at a relatively lower cost.

The correct answer is option 'A', which states that both Assertion (A) and Reason (R) are true, and Reason (R) is the correct explanation of Assertion (A). Let's break down the explanation for better understanding:

Explanation:
The Gross Profit ratio is an important financial ratio that indicates the profitability of a business. It is calculated by dividing the gross profit (sales minus the cost of goods sold) by the net sales and multiplying by 100. The higher the gross profit ratio, the better it is for the business, while a lower ratio is not good for the business.

Importance of Gross Profit Ratio:
The Gross Profit ratio reflects the efficiency with which a firm produces its products. It indicates how well the organization is able to control its production costs and generate profit from its operations. A high gross profit ratio suggests that the business is able to produce its goods or services at a relatively lower cost compared to its competitors. This can be achieved through effective cost management, efficient production processes, and economies of scale.

Benefits of a Higher Gross Profit Ratio:
1. Increased Profitability: A higher gross profit ratio indicates that the business is generating more profit from its operations. This can lead to increased overall profitability.
2. Competitive Advantage: A lower cost of production allows the business to offer its products or services at a competitive price, giving it an advantage over competitors.
3. Financial Stability: Higher profits provide the business with more financial stability and resources for growth, investment, and expansion.

Reason (R) Explanation:
The Reason (R) provided in the statement correctly explains why a higher gross profit ratio is good for the business. A high gross profit ratio indicates that the organization is able to produce its products at a relatively lower cost. This reflects efficiency in production processes, effective cost management, and the ability to take advantage of economies of scale. As a result, the business is able to generate higher profits and maintain a competitive edge in the market.

In conclusion, a higher gross profit ratio is indeed good for the business as it reflects efficiency in production and allows for increased profitability and competitiveness. The Reason (R) provided correctly explains the relationship between a high gross profit ratio and the organization's ability to produce at a relatively lower cost.

Liquid ratio analyses liquid assets and liquid liabilities of a business unit in order to assess the extent of liquidity.

Assertion (A): Debt to Equity Ratio of 2 : 1 is considered satisfactory. Generally a Low Ratio is considered favourable.
Reason (R): This ratio indicates the proportionate claims of owners and outsiders on a firm's assets. High Ratio shows claims of outsiders are greater but Low Ratio shows outsiders claims are less.

The given Assertion (A) states that a Debt to Equity Ratio of 2:1 is considered satisfactory, while a low ratio is considered favorable. The Reason (R) provided is that this ratio indicates the proportionate claims of owners and outsiders on a firm's assets. A high ratio shows that the claims of outsiders are greater, while a low ratio shows that the claims of outsiders are less.

Explanation:

Debt to Equity Ratio:
The debt to equity ratio is a financial ratio that compares a company's total debt to its shareholders' equity. It is a measure of the company's financial leverage and indicates the proportion of financing provided by the company's creditors (debt) compared to the financing provided by the company's owners (equity).

Interpretation of Debt to Equity Ratio:
- A Debt to Equity Ratio of 2:1 means that the company has twice as much debt as equity. This indicates that the company relies more on debt financing than on equity financing.
- A low Debt to Equity Ratio indicates that the company has a smaller proportion of debt compared to equity. This suggests that the company relies more on equity financing and has lower financial risk.
- A high Debt to Equity Ratio indicates that the company has a larger proportion of debt compared to equity. This suggests that the company relies more on debt financing and has higher financial risk.

Analysis:
The Assertion (A) states that a Debt to Equity Ratio of 2:1 is considered satisfactory. This means that the company has a balanced mix of debt and equity financing, indicating a moderate level of financial risk. A ratio lower than 2:1 would be even more favorable as it suggests a lower level of debt and lower financial risk.

The Reason (R) provided explains the significance of the Debt to Equity Ratio. It states that the ratio indicates the proportionate claims of owners and outsiders on a firm's assets. A high ratio implies that the claims of outsiders (creditors) are greater, indicating higher financial risk. On the other hand, a low ratio implies that the claims of outsiders are less, indicating lower financial risk.

Conclusion:
Both the Assertion (A) and Reason (R) are true, and the Reason (R) is the correct explanation of the Assertion (A). A Debt to Equity Ratio of 2:1 is considered satisfactory, and a low ratio is considered favorable as it indicates a lower level of debt and lower financial risk. The Reason (R) explains that the ratio reflects the proportionate claims of owners and outsiders on a firm's assets, with a high ratio indicating greater claims of outsiders and a low ratio indicating lesser claims of outsiders.