CURRENT RATIO The most common ratio using current-asset and
data is the current ratio, which is current assets divided by current
Recall the makeup of current assets and current liabilities. Inventory is
to receivables through sales, the receivables are collected in cash, and the
cash is used to buy inventory and pay current liabilities. A company's
current assets and current liabilities represent the core of its day-to-day
operations. The current ratio measures the company's ability to pay current
assets with current liabilities. Generally a higher current ratio indicates
a stronger financial position. A higher current ratio suggests that the
business has sufficient liquid assets to maintain normal business
ACID-TEST RATIO The acid-test (or quick) ratio tells us whether the entity
could pay all its current liabilities if they came due immediately. รท That
is, could the company pass this acid test? To do so, the company would have
to convert its most liquid assets to cash.
To compute the acid-test ratio, we add cash, short-term investments, and net
current receivables (accounts and notes receivable, net of allowances) and
divide by current liabilities. Inventory and prepaid expenses are the two
current assets not included in the acid-test computations because they are
the least liquid of the cur rent assets. A business may not be able to
convert them to cash immediately to pay current liabilities. The acid-test
ratio uses a narrower asset base to measure liquidity than the current ratio
does. An acid-test ratio of 0.90 to 1.00 is acceptable in most industries.
INVENTORY TURNOVER is a measure of the number of times a company sells its
average level of inventory during a year. A high rate of turnover indicates
relative ease in selling inventory; a low turnover indicates difficulty in
selling. In general, companies prefer a high inventory turnover. A value...