Analysis of accounts — practice questions

Current ratio = 240 000 ÷ 160 000 = 1.5 : 1

Acid test = (240 000 − 90 000) ÷ 160 000 = 150 000 ÷ 160 000 = 0.94 : 1

Comment: Current ratio suggests adequate cover, but acid test below 1:1 — without selling inventory, the firm may struggle to pay short-term debts. Consider reducing inventory or speeding up receivables collection.

1. Current Ratio

This ratio measures if the company has enough current assets to cover its current liabilities.

$\frac{\text{Current Assets}}{\text{Current Liabilities}} = \frac{\text{\textdollar}350,000}{\text{\textdollar}150,000} = 2.33$

The current ratio is 2.33 : 1.

2. Acid Test (Quick) Ratio

This is a stricter test that excludes inventory, which can be hard to sell quickly.

$\frac{\text{Current Assets} - \text{Inventories}}{\text{Current Liabilities}} = \frac{\text{\textdollar}350,000 - \text{\textdollar}200,000}{\text{\textdollar}150,000} = \frac{\text{\textdollar}150,000}{\text{\textdollar}150,000} = 1$

The acid test ratio is 1 : 1.

3. Comment

The current ratio of 2.33:1 is strong, suggesting the business is in a good position to pay its short-term debts. However, the acid test ratio of 1:1, while acceptable, reveals a heavy dependence on inventory. The large difference between the two ratios indicates that a significant portion of current assets is tied up in stock. If this inventory is slow-moving or becomes obsolete, the company's liquidity position would be much weaker than the current ratio suggests.