Question

Company A has a current ratio of 2.50 and a quick ratio of 1.25. What can you tell me about company A? Is company A better or worse than company B with a current ratio of 3.20 and a quick ratio of 1.25? What else would you need to know to better determine which company is best? Justify your response.

Answer 1

We know that, Current ratio = Current Assets / Current Liabilities

Quick ratio = (Current Assets - Inventory) / Current Liabilities

Given that,

For Company A,

The current ratio indicates that the firm has $2.5 worth of current assets for every $1 of short term liabilities. However, as per quick ratio, it has $1.25 worth of current assets for every $1 of short term liabilities. Both the numbers indicate a good financial position as the current ratio is more than 2 and the Quick ratio is more than 1. We can note that, out of $2.5 assets, half of them is inventory which is removed in quick ratio. The firm should have more liquid assets in order to be more responsive to short term obligations.

In comparison with Company B,

Company A is worse off than company B as it has only $2.5 assets for every $1 of liabilities. While company B has $3.2 assets for every $1 of liabilities. However, for quick ratio, they both are at same position of $1.25 assets for every $1 of liabilities. We can note that, company A has only $1.25 as inventory while the company has $1.95 which is less liquid. So company A is better off than company B in order to be more responsive to short term obligations.