Compute the (a) current ratio and (b) acid-test ratio.
Understand the Problem
The question is asking to compute the current ratio and acid-test ratio based on the provided financial figures. It requires calculating two financial ratios that assess liquidity: the current ratio, which measures the ability to cover current liabilities with current assets, and the acid-test ratio, which evaluates the ability to pay current liabilities without relying on inventory.
Answer
The current ratio is $2.7$ and the acid-test ratio is $1.1$.
Answer for screen readers
The current ratio is $2.7$ and the acid-test ratio is $1.1$.
Steps to Solve
- Calculate Total Current Assets To find the current ratio, first, we need to sum up all the current assets.
Current assets = Cash + Short-term investments + Accounts receivable + Inventory + Prepaid assets
So, $$ \text{Total current assets} = 20,600 + 3,600 + 11,000 + 35,200 + 16,000 = 86,400 $$
- Identify Current Liabilities The total current liabilities have already been provided in the problem.
Current liabilities = $32,000.
- Calculate the Current Ratio Using the total current assets and current liabilities, calculate the current ratio.
The formula for Current Ratio is: $$ \text{Current Ratio} = \frac{\text{Total Current Assets}}{\text{Total Current Liabilities}} = \frac{86,400}{32,000} $$
- Perform the Calculation Now calculate the current ratio.
$$ \text{Current Ratio} = 2.7 $$
- Calculate the Acid-Test Ratio The acid-test ratio excludes inventory from current assets.
The formula for Acid-Test Ratio is: $$ \text{Acid-Test Ratio} = \frac{\text{Cash} + \text{Short-term investments} + \text{Accounts Receivable}}{\text{Total Current Liabilities}} $$
Using the values: $$ \text{Acid-Test Ratio} = \frac{20,600 + 3,600 + 11,000}{32,000} $$
- Perform the Calculation for Acid-Test Ratio Now calculate the acid-test ratio.
$$ \text{Acid-Test Ratio} = \frac{35,200}{32,000} = 1.1 $$
The current ratio is $2.7$ and the acid-test ratio is $1.1$.
More Information
The current ratio of $2.7$ indicates that for every dollar of current liabilities, there are $2.7$ in current assets, suggesting good short-term financial health. The acid-test ratio of $1.1$ indicates that even without inventory, there are sufficient liquid assets to cover current liabilities.
Tips
- Forgetting to exclude inventory when calculating the acid-test ratio.
- Not double-checking the addition of current assets.
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