Question

Identify which of the following six metrics a through f best completes questions 1 through 3 below.

a. Days’ sales uncollectedd. Return on total assets

b. Accounts receivable turnover e. Total asset turnover

c. Working capitalf. Profit margin

1. Which two ratios are key components in measuring a company’s operating efficiency? Which ratio summarizes these two components?

2. What measure reflects the difference between current assets and current liabilities?

3. Which two short-term liquidity ratios measure how frequently a company collects its accounts?

Short answer

1. Profit margin and total asset turnover ratiodetermine the company’s operating efficiency.Return on total assets combined the components of profit margin and total asset turnover.
2. Working capital.
3. Day’s sales uncollected andaccounts receivable turnover ratio.

Step-by-step solution

Definition of Financial Ratios

Financial ratios refer to those ratios that compare the two or more items of the financial statements.

Ratios measuring the company’s operating efficiency

The correct options are (d)Return on total assets, (e) Total asset turnover, and (f) Profit margin

The profit margin and total asset turnover ratio determine the company's operating efficiency. Return on total asset summarizes the above two components.

The profit margin ratio calculates the percentage of revenue converted into gross profit or net profit.

Total asset turnover ratio: It determines the company’s efficiency in using its assets for generating revenue.

Return on total assets: It determines the ability of the business entity to generate profit by use of its assets. Therefore, it combines the components of both profit margin and total assets turnover.

Measure that reflects the difference between the current assets and current liabilities

The correct option is (c) Working Capital.

Working capital can be defined as the measure of determining the short-term financial health of the business entity. It calculates the difference that exists between the current assets and current liabilities. It determines the ability of the business entity to cover the obligations towards current liabilities using the current assets.

Short-term liquidity measures

The correct options are (a) Day’s sales uncollected and (b) Accounts receivable turnover.

Days of sales uncollected is the financial metric determining the number of days for which the amount of accounts receivable will remain uncollectible.

Accounts receivable turnover ratio: This ratio determines the efficiency of the business entity in collecting cash from the receivables.