Test: Ratio Analysis -1 - UGC NET MCQ

The Quick Ratio, also known as the Acid-Test Ratio, evaluates the relationship between a business's quick assets (current assets excluding inventory, prepaid expenses, advance tax, and accrued income) and its current liabilities. It is a crucial measure of a company's ability to promptly pay off its short-term liabilities with its most liquid assets. A Quick Ratio of 1:1 is generally considered ideal, indicating that a company has enough liquid assets to cover its immediate obligations without relying on selling inventory.

• Statement 1 is correct as the operating profit ratio indicates the margin of operating profits available on Revenue from Operations to cover non-operating expenses.
• Statement 2 is also accurate as a higher ratio usually signifies better profitability in financial terms.
• Therefore, both statements are correct, making option C the correct answer.

• Assertion (A): The assertion is correct. A higher debtors turnover ratio indicates that a company is collecting cash from its credit customers quickly, showcasing effective management of trade receivables.
• Reason (R): The reason is correct. Debtors turnover ratio measures how rapidly cash is collected from trade receivables, reflecting the efficiency of cash realization from credit sales.
• Explanation: The reason correctly explains why a higher debtors turnover ratio signifies effective management of trade receivables. It correlates the ratio with the speed of cash realization from credit sales.

• Assertion (A): The assertion is correct. A lower creditors turnover ratio suggests that payments to trade payables are taking longer, potentially indicating extended credit periods.
• Reason (R): The reason is false. The creditors turnover ratio actually measures how quickly a company pays its trade payables, not the length of credit periods available for payments.
• Explanation: Although the assertion is true, the reason is incorrect. The creditors turnover ratio doesn't directly relate to the availability of credit periods but focuses on the speed of payments to creditors.

Heightened Competition:

• Rising promotion costs and shrinking profit margins are often the result of heightened competition.
• When competition in a market intensifies, firms may need to spend more on marketing and advertising to differentiate their products or services and attract customers.
• This can lead to rising promotion costs. At the same time, competition can drive down prices and reduce profit margins as firms compete for market share. In an effort to maintain their margins, firms may need to increase sales volume or reduce costs, which can also put pressure on promotion costs.
• In some cases, rising promotion costs and shrinking profit margins may also be the result of changes in consumer behavior or technological disruption.
• For example, if consumers are increasingly turning to online channels to shop and compare prices, firms may need to invest in digital marketing and e-commerce capabilities to remain competitive. This can lead to rising promotion costs, particularly if firms are competing with online marketplaces that can offer lower prices due to their lower overhead costs.

Hence, the correct answer is Heightened Competition.

An asset is classified as current when it is expected to be realized within twelve months after the reporting date. This classification helps in assessing a company's short-term liquidity and ability to meet its obligations promptly.

• Assertion (A): The assertion is correct. A higher working capital turnover ratio indicates that working capital is being effectively utilized to generate revenue.
• Reason (R): The reason is correct. Working capital turnover ratio measures how efficiently working capital is being used concerning revenue from operations, reflecting the effectiveness of capital deployment.
• Explanation: The reason provides a correct explanation for why a higher working capital turnover ratio signifies efficient utilization of working capital. It directly links the ratio to the efficiency of capital deployment in generating revenue.

Liquidity Ratios gauge a company's ability to meet its short-term obligations, specifically its ability to pay current dues. They provide insight into the firm's short-term solvency by assessing how easily current liabilities can be covered by current assets. This is crucial for understanding a company's financial health in the short run.

Liquidity ratios in a business measure the firm's ability to pay its short-term obligations promptly. These ratios provide insights into a company's short-term solvency and its capacity to meet current liabilities as they come due. Maintaining healthy liquidity ratios is crucial to ensure a business can handle its immediate financial obligations without facing liquidity issues.

• Assertion (A): The assertion is correct. A high inventory turnover ratio generally indicates efficient management of stock because it shows that products are selling quickly, reducing the risk of obsolete inventory.
• Reason (R): The reason is correct. Inventory turnover ratio calculates how many times inventory is sold and replaced over a period, reflecting the efficiency of stock management.
• Explanation: While both the assertion and reason are true, the reason does not explain why a high inventory turnover ratio signifies efficient stock management. It merely describes what the ratio measures, without directly linking it to efficiency.