In: Finance
Based on the Working Capital table below, which of the following two firms would a lender view more favorably and why? Show your work.
Company A |
Company B |
|
Current Assets |
$ 1,250,000 |
$ 700,000 |
Current Liabilities |
$ 700,000 |
$ 200,000 |
Working Capital |
$ 550,000 |
$ 500,000 |
Answer ) Company B
Current Ratio is the "liquidity ratio." It is a measure of the firm's ability to pay its short-term debt. It calculates the assets that must be converted to cash during the year period in order to sufficiently pay the current debt that is owed.
Current ratio= current asset/current liability
For company A
CR= 1250000/700000 = 1.79
For company B
CR = 700000/200000 = 3.5
The one with higher current ratio is more likely to not default the payment as compared to with lower current ratio so the lender will choose company B for less risk consideration