Current Ratio Analysis
Calculate and interpret the current ratio for a company.
Problem Scenario
ABC Corp has cash $50K, receivables $120K, inventory $80K, and current liabilities $200K.
Given Data
Requirements
- Calculate current ratio
- Calculate quick ratio
- Interpret both
Solution
Step 1:
Current assets = 50K + 120K + 80K = $250K.
Step 2:
Current ratio = 250K / 200K = 1.25.
Step 3:
Quick ratio = (250K - 80K) / 200K = 170K / 200K = 0.85.
Final Answer
Current ratio = 1.25. Quick ratio = 0.85. Liquidity is marginal; quick ratio below 1.0 suggests reliance on inventory to cover short-term obligations.
Key Takeaways
- ✓Quick ratio excludes inventory for a stricter test
- ✓Compare to industry averages
Common Errors to Avoid
- ✗Including non-current assets in the numerator
- ✗Forgetting to exclude inventory for quick ratio
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Common questions about this problem type
The firm may struggle to meet short-term obligations without additional financing or asset sales.
The quick ratio strips out inventory, giving a stricter liquidity test. A company with a strong current ratio but weak quick ratio may be holding too much slow-moving inventory, which is harder to convert to cash in a pinch.