Question

ssignment 04 - Analysis of Financial Statements 2. Liquidity ratios Аа д Most firms borrow money to finance some of their assets, and most will choose to borrow some long-term funds and some short- funds. Which group of lenders would put greater emphasis on a firm's liquidity ratio when evaluating a potential borrower? Long-term lenders Short-term lenders The most recent data from the annual balance sheets of N&B Equipment Company and Jing Foodstuffs Inc. are as follows: Jing Foodstuffs Inc. Jing Foodstuffs Inc. N&B Equipment Company $0 Assets Current assets Cash Accounts receivable Inventories Total current assets Net fixed assets Net plant and equipment $861 315 924 2,100 Balance Sheet December 31st (Millions of dollars) N&B Equipment Company Liabilities Current liabilities $553 Accounts payable 203 Accruals 594 Notes payable 1,350 Total current liabilities Long-term bonds 1,650 Total debt Common equity Common stock Retained earnings Total common equity 3,000 Total liabilities and equity 190 1,075 1,265 1,012 1,012 1,547 1,238 2,250 1,650 2,812 610 328 488 262 750 3,000 938 Total assets 3,750 3,750

Answer 1

Answer a.

Liquidity ratio measures the ability of the firm to pay its short-term obligation.
Short-term lenders would put greater emphasis on a firm’s liquidity ratio when evaluating a potential borrowed.

Answer b.

Jing Foodstuffs Inc.:

Current Ratio = Current Assets / Current Liabilities
Current Ratio = $2,100 / $1,265
Current Ratio = 1.6601

Quick Ratio = (Current Assets - Inventories) / Current Liabilities
Quick Ratio = ($2,100 - $924) / $1,265
Quick Ratio = 0.9296

N&B Equipment Company:

Current Ratio = Current Assets / Current Liabilities
Current Ratio = $1,350 / $1,012
Current Ratio = 1.3340

Quick Ratio = (Current Assets - Inventories) / Current Liabilities
Quick Ratio = ($1,350 - $594) / $1,012
Quick Ratio = 0.7470

N&B Equipment Company’s current ratio is 1.3340, and its quick ratio is 0.7470; Jing Foodstuffs Inc.’s current ratio is 1.6601, and its quick ratio is 0.9296.

Answer c.

Jing Foodstuffs Inc. has a better ability to meet its short-term liabilities than N&B Equipment Company.
A current ratio of 1 indicates that the book value of the company’s current assets is equal to the book value of current liabilities.
If a company has a quick ratio of less than 1 but a current ratio of more than 1 and if the difference between the two ratios is large, then the company depends heavily on the sale of its inventory to meet its short-term obligations.
An increase in the current ratio over time always means that the company’s liquidity position is improving.