You are evaluating the balance sheet for PattyCake\'s Corporation. From the bala

Question

You are evaluating the balance sheet for PattyCake's Corporation. From the balance sheet you find the following balances: cash and marketable securities-$490,000; accounts receivable-$1,020,000; inventory-$1,920,000, accrued wages and taxes = $410,000; accounts payable $710,000; and notes payable $420,000 Calculate PattyCakes' current ratio. (Round your answer to 2 decimal places.) Current ratio Calculate Patty Cakes' quick ratio. (Round your answer to 2 decimal places.) Calculate PattyCakes' cash ratio. (Round your answer to 2 decimal places.) Cash ratio Prev 10130m Next > 13

Explanation / Answer

PattyCake's Corporation

3430000

1. Current Ratio

= Current Assets / Current Liabilities

= $3430000 / $1540000

= 2.23 Times

Current ratio (also known as working capital ratio) is a popular tool to evaluate short-term solvency position of a business. Short-term solvency refers to the ability of a business to pay its short-term obligations when they become due. Short term obligations (also known as current liabilities) are the liabilities payable within a short period of time, usually one year.

Current ratio is a useful test of the short-term-debt paying ability of any business. A ratio of 2:1 or higher is considered satisfactory for most of the companies but analyst should be very careful while interpreting it.

A company with high current ratio may not always be able to pay its current liabilities as they become due if a large portion of its current assets consists of slow moving or obsolete inventories. On the other hand, a company with low current ratio may be able to pay its current obligations as they become due if a large portion of its current assets consists of highly liquid assets i.e., cash, bank balance, marketable securities and fast moving inventories.

2. Quick Ratio

= Current Assets - Inventories

Current Liabilities

= $3430000 - $1920000

$1540000

= $1510000 / $1540000

= 0.98 Times

The quick ratio is an indicator of a company’s short-term liquidity, and measures a company’s ability to meet its short-term obligations with its most liquid assets. Because we're only concerned with the most liquid assets, the ratio excludes inventories from current assets.
A quick ratio lower than 1 does not necessarily mean the company is going into default or bankruptcy, it could mean that the company is relying heavily on inventory or other assets to pay its short term liabilities. The higher the quick ratio, the better the company's liquidity position. However, too high a quick ratio may indicate that the company has too much cash sitting in its reserves. It may also mean that the company has a high accounts receivables, indicating that the company may be having problems collecting on its account receivables.

3. Cash Ratio

= Cash & Cash Equivalents / Current Liabilities

= $490000 / $1540000

= 0.32 Times

Cash ratio is the ratio of cash and cash equivalents of a company to its current liabilities. It is an extreme liquidity ratio since only cash and cash equivalents are compared with the current liabilities. It measures the ability of a business to repay its current liabilities by only using its cash and cash equivalents and nothing else.

A cash ratio of 1.00 and above means that the business will be able to pay all its current liabilities in immediate short term. Therefore, creditors usually prefer high cash ratio. But businesses usually do not plan to keep their cash and cash equivalent at level with their current liabilities because they can use a portion of idle cash to generate profits. This means that a normal value of cash ratio is somewhere below 1.00.

Particulars Current Assets (in $) Cash & Marketable securities 490000 Accounts Receivable 1020000 Inventory 1920000 Total

3430000

Related Questions

Navigate

• Browse (All)
• Browse Y
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.