Lesson 19 Flashcards
Why is the distinction between current liabilities and long term debt important?
It provides information about the liquidity of the company.
Why is a liquid company a good thing?
- it is better able to withstand a financial downturn
- has a better chance of taking advantage of investment opportunities that develop
How do companies assess liquidity?
They use net cash flow, and the turnover ratios, current ratio, and the acid test ratio.
Define the current ratio.
is the ratio of total current assets to total current liabilities
What is the formula for the current ratio?
Current Assets / Current liabilities
What is another name for current ratio?
Working capital ratio
What is another name for acid-test ratio?
Quick Ratio
Define the acid test ratio.
It is a liquidity ratio that measures the ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately.
What is the formula for acid test ratio?
Cash + Short Term Investments + Accounts Receivable / Current Liabilities
Presented below is information available for Marley Company.
Current Assets
Cash: $4,000
Short-term investments: $55,000
Accounts receivable: $61,000
Inventory: $110,000
Prepaid expenses: $30,000
Total current assets $260,000
Total current liabilities are $100,000.
What is the acid-test ratio for Marley?
1.20 to 1
Correct. The acid-test ratio is calculated as: (Cash + Short Term Investments + Accounts Receivable) / Current Liabilities. Marley’s acid-test ratio is: [($4,000 + $55,000 + $61,000) / 100,000] = 1.2 to 1.
What is another formula for Acid Test Ratio (Quick Ratio)?
Current Assets - Inventory - Prepaid Expenses / Current Liabilities
