Potz and Pans, a small gift shop, has current assets of $45,000 (including inven

Question

Potz and Pans, a small gift shop, has current assets of $45,000 (including inventory valued at $30,000) and $9,000 in current liabilities. WannaBees, a specialty clothing store, has current assets of $150,000 (including inventory valued at $125,000) and $85,000 in current liabilities. Both businesses have applied for loans. Click the Calculators box on the toolbar at www.bankrate.com and then click on Small Business to answer the following questions:

1. Calculate the current ratio for each company. Which company is more likely to get the loan? Why?

(I understand that Potz and Pans would be the most eligible company to get the loan because of their ratio but I don't understand the reason behind it.)

2. The acid-test ratio subtracts the value of the firm's inventory from its total current assets. Because inventory is often difficult to sell, this ratio is considered an even more reliable measure of a business's ability to repay loans than the current ratio. Calculate the acid-test ratio for each business and decide whether you would give either the loan. Why or why not?

Explanation / Answer

Current Assets Ratio Potz and Plans Current Asset Ratio= Current Assets/ Current Liabilities 45000/9000 5 WannaBeas Current Asset Ratio= 150000/85000 1.764706 Potz and Pans has more current Asset Ratio and he will get the loan as he can more easily repay the loan Acid Test Ratio= Current Assets- Inventories/ Current Liabilities Potz and Pans Acid Test Ratio= 45000-30000/9000 15000/9000 1.67 WannaBees Acid Test Ratio= 150000-125000/85000 25000/85000 0.29 Potz and Pans has more Acid Test Ratio and Potz and Pans will get the loan as he can easily repay the loans

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