Answer to Question #230392 in Accounting for Zannath

Question

2. a. Josh Smith has compiled some of the data of his business in order to analyze his position. The data are as follows.

Account Amount

Cash 3200

Inventory 2800

Checking account 800

Accounts payables 700

Short-term notes payables 2100

i. Calculate Josh’s liquidity ratios.

ii. Several of Josh’s friends are doing different business. They have told him that they have current ratio and quick ratio of about 1.8 and 1.1 respectively. How would you analyze Josh’s liquidity relative to his friends?

iii. What problem might you find in comparing these ratios? 3

Answer 1

1. Liquidity ratio=current assets/current liabilities

=(cash+marketable securities+checking account)/(credit card payables+short term notes payable)

=(3200+1000+800)/(1200+900)

=2.38 approximately

2. Josh has a larger liquidity ratio than his buddies, which means that his current liabilities can be paid off faster because he has more current assets to cover them. Liquidity ratios indicate that a corporation is more liquid and has better coverage of its outstanding debts when they are higher. Comparing the liquidity ratios of one company to another or an entire industry is an alternative to external analysis.

3.If you want to be clear about the liquidity situation of a corporation, only the present proportion and rapid ratio are not adequate. And you need to know which sector and business you're calculating for, because the same ratio wouldn't give the exact picture on every occasion. In general, before forming any judgments, they must consider all liquidity ratios.

References

Purnomo, A. (2018). Influence of the ratio of profit margin, financial leverage ratio, current ratio, quick ratio against the conditions and financial distress. Indonesian Journal of Business, Accounting and Management, 1(1).

Madushanka, K. H. I., & Jathurika, M. (2018). The impact of liquidity ratios on profitability. International Research Journal of Advanced Engineering and Science, 3(4), 157-161.