Compute the (a) current ratio and (b) acid-test ratio for Pritchett Company based on the year-end data provided.
Understand the Problem
The question is asking for the computation of two financial ratios: the current ratio and the acid-test ratio based on the provided year-end data from Pritchett Company. We will calculate the current assets and total current liabilities to find these ratios.
Answer
Current Ratio: $2.7$, Acid Test Ratio: $1.1$
Answer for screen readers
- Current Ratio: $2.7$
- Acid Test Ratio: $1.1$
Steps to Solve
-
Identify Current Assets
Current assets consist of cash, short-term investments, accounts receivable, inventory, and prepaid assets. We will sum these up:
$$ \text{Current Assets} = \text{Cash} + \text{Short-term Investments} + \text{Accounts Receivable} + \text{Inventory} + \text{Prepaid Assets} $$
Substituting the values:
$$ \text{Current Assets} = 20,600 + 3,600 + 11,000 + 35,200 + 16,000 $$ -
Sum Current Assets
Calculating the total of current assets:
$$ \text{Current Assets} = 20,600 + 3,600 + 11,000 + 35,200 + 16,000 = 86,400 $$ -
Identify Current Liabilities
We already have the total current liabilities from the data:
$$ \text{Total Current Liabilities} = 32,000 $$ -
Calculate the Current Ratio
The current ratio is calculated by dividing current assets by current liabilities:
$$ \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} $$
Substituting the values:
$$ \text{Current Ratio} = \frac{86,400}{32,000} $$ -
Sum the Current Ratio
Calculating the current ratio:
$$ \text{Current Ratio} = 2.7 $$ -
Identify Liquid Assets for Acid Test Ratio
For the acid-test ratio, we consider only liquid assets: cash, short-term investments, and accounts receivable.
$$ \text{Liquid Assets} = \text{Cash} + \text{Short-term Investments} + \text{Accounts Receivable} $$
Substituting the values:
$$ \text{Liquid Assets} = 20,600 + 3,600 + 11,000 $$ -
Sum Liquid Assets
Calculating the total of liquid assets:
$$ \text{Liquid Assets} = 20,600 + 3,600 + 11,000 = 35,200 $$ -
Calculate the Acid Test Ratio
The acid-test ratio is calculated similarly to the current ratio but uses liquid assets:
$$ \text{Acid Test Ratio} = \frac{\text{Liquid Assets}}{\text{Current Liabilities}} $$
Substituting the values:
$$ \text{Acid Test Ratio} = \frac{35,200}{32,000} $$ -
Sum the Acid Test Ratio
Calculating the acid-test ratio:
$$ \text{Acid Test Ratio} = 1.1 $$
- Current Ratio: $2.7$
- Acid Test Ratio: $1.1$
More Information
The current ratio measures a company's ability to pay short-term obligations, while the acid-test ratio indicates the ability to pay off current liabilities without relying on inventory sales. A current ratio and acid-test ratio both above 1 imply good financial health.
Tips
- Neglecting to include all current assets: Ensure all components are considered for accurate ratios.
- Confusing current assets with liquid assets: Remember that the acid-test ratio only includes cash, short-term investments, and receivables.
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