Which of the following statements about ratios is false?
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A. B. C. D. E.D
The usefulness of ratio analysis is highly dependent upon skillful interpretation by the analyst.
The correct answer is D. "The advantage of ratio analysis is that very little skill is required in interpreting the meaning of the ratios."
Ratio analysis is a technique used in financial analysis to evaluate the performance and financial health of a company. It involves calculating and interpreting various ratios that express mathematical relationships between different economically important quantities, such as financial statement items.
Statement A is true. Analysis of ratios can identify areas that require further investigation. Ratios provide insights into a company's financial performance and can help identify areas of concern or potential strengths. For example, if a company's liquidity ratios indicate a potential liquidity problem, further investigation into its cash flow position and working capital management may be necessary.
Statement B is true. Ratios do express mathematical relations between economically important quantities. Examples of commonly used ratios include profitability ratios (such as return on equity or gross profit margin), liquidity ratios (such as current ratio or quick ratio), and solvency ratios (such as debt-to-equity ratio or interest coverage ratio).
Statement C is true. A ratio expresses a mathematical relation between two or more economically important quantities. Ratios are calculated by dividing one quantity by another to provide a relative measure or comparison. For example, the current ratio is calculated by dividing current assets by current liabilities to assess a company's short-term liquidity position.
Statement D is false. The advantage of ratio analysis is not that very little skill is required in interpreting the meaning of the ratios. In fact, ratio analysis requires a certain level of skill and knowledge to interpret the ratios accurately and derive meaningful insights from them. Interpreting ratios involves understanding the context of the ratios, considering industry benchmarks or historical trends, and analyzing the underlying factors that influence the ratios.
Statement E is true. Ratios must be interpreted with care since factors affecting the numerator (the value in the ratio's top) can correlate with those affecting the denominator (the value in the ratio's bottom). It is important to consider the underlying factors that drive the numerator and the denominator to ensure a proper understanding of the ratio's implications. For example, if a company's profitability ratio decreases, it could be due to a decrease in sales (numerator) or an increase in costs (denominator), or a combination of both.
Therefore, the false statement is D.