Correct Option: B. Current Ratio Explanation of the Correct Answer The Current Ratio is a financial metric that measures a company's ability to pay off its short-term liabilities with its short-term assets. It is calculated using the formula: [ \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} ]

• Current Assets include cash, accounts receivable, inventory, and other assets that are expected to be converted into cash or used up within one year.
• Current Liabilities are obligations that the company needs to settle within one year, such as accounts payable, short-term loans, and other similar debts.

A Current Ratio greater than 1 indicates that the company has more current assets than current liabilities, suggesting it is in a good position to cover its short-term obligations. Conversely, a ratio less than 1 may indicate potential liquidity problems, as the company may not have enough short-term assets to meet its short-term debts. Why the Other Options Are Incorrect A. Debt to Equity Ratio - The Debt to Equity Ratio measures a company's financial leverage by comparing its total liabilities to its shareholders' equity. It is calculated as: [ \text{Debt to Equity Ratio} = \frac{\text{Total Liabilities}}{\text{Shareholders' Equity}} ]

• This ratio is primarily used to assess the long-term financial stability and risk of a company, not its ability to meet short-term obligations.

C. Return on Equity (ROE) - Return on Equity measures a company's profitability by revealing how much profit a company generates with the money shareholders have invested. It is calculated as: [ \text{ROE} = \frac{\text{Net Income}}{\text{Shareholders' Equity}} ]

• While ROE is an important measure of financial performance, it does not provide insight into a company's short-term liquidity or its ability to meet short-term obligations.

D. Gross Profit Margin - The Gross Profit Margin indicates the percentage of revenue that exceeds the cost of goods sold (COGS). It is calculated as: [ \text{Gross Profit Margin} = \frac{\text{Gross Profit}}{\text{Revenue}} \times 100 ]

• This ratio is useful for assessing a company's production efficiency and pricing strategy, but it does not directly relate to the company's ability to meet short-term liabilities.

Summary of Key Points

• The Current Ratio is the primary measure of a company's ability to meet short-term obligations.
• A ratio greater than 1 indicates good short-term financial health, while a ratio less than 1 may signal liquidity issues.
• Other ratios like Debt to Equity, Return on Equity, and Gross Profit Margin focus on different aspects of financial health and performance, not specifically on short-term obligations.

Revision Summary

• Current Ratio assesses short-term liquidity.
• A ratio > 1 indicates good ability to meet obligations.
• Other ratios focus on long-term stability, profitability, or efficiency.
• Understanding the purpose of each ratio is crucial for financial analysis.