Question

Please answer both parts

Liquidity ratio Josh Smith has compiled some of his personal financial data in order to determine his liquidity position. The data are as follows Account Amount Cash Marketable securities Checking account Credit card payables Short-term notes payable $3,280 1,030 770 1,220 1030 a. Calculate Josh's liquidity ratio b. Several of Josh's friends have told him that they have liquidity ratios of about 1.7. How would you analyze Josh's liquidity relative to his friends? a. Josh's liquidity ratio is[. (Round to two decimal places.) b. Several of Josh's friends have told him that they have liquidity ratios of about 1.7. How would you analyze Josh's liquidity relative to his friends? (Select all the answers that apply.) ? A. Josh's ratio indicates that he is in a relatively inferior position to satisfy his existing short-term debt obligations as they come due B. Since Josh's liquidity ratio exceeds 1.7, Josh has more liquidity than his friends ? C. Since Josh's liquidity ratio exceeds 1.7, Josh has less liquidity than his friends

Answer 1

Solution :

Part a:

Liquidity ratio or Current Ratio = Current Assets / Current Liabilities

Josh's Liquidity ratio =

(Cash + Marketable Securities + Checking account) / (Credit card payables + Short term Notes payable)

= ( $ 3,280 + $ 1030 + $ 770 ) / ( $ 1,220 + $ 1030 )

= ( $ 5,080 / $ 2,250 ) = 2.257 = 2.26 (when rounded off to two decimals)

Thus Josh's Liquidity ratio is 2.26.

Part b :

Since Josh's liquidity ratio exceeds 1.7, Josh has more liquidity than his friends.

If the current ratio is more than 1, it implies that the individual has current assets are more than the current liabilities. The current asets are more than sufficient to fulfill / discharge its current liabilties.

As the current ratio of Josh is 2.26, it means that its current assets are more than twice the amount of its current liabilities, which can be used to discharge the current liabilities obligations as and when a need arises.

Thus Josh has more liquidity than his friends.

The solution to part b of the question is option B.