Question

Task

To calculate and analyze the current and quick (acid-test) ratios of different businesses.

Potz and Pans, a small gift shop, has current assets of $45,000 (including inventory valued at $30,000) and $9,000 in current liabilities. WannaBees, a specialty clothing store, has current assets of $150,000 (including inventory valued at $125,000) and $85,000 in current liabilities.

Both businesses have applied for loans. Click the “See all calculators” link at bankrate.com and then click on “Small Business” to answer the following questions:

1. Calculate the current ratio for each company. Which company is more likely to get the loan? Why?

2. The acid-test (or quick) ratio subtracts the value of the firm’s inventory from its total current assets. Because inventory is often difficult to sell, this ratio is considered an even more reliable measure of a business’s ability to repay loans than the current ratio. Calculate the quick ratio for each business and decide whether you would give either the loan. Why or why not?

Answer 1

Shops	Potz and Pans	WannaBees
Business Detail	small gift shop	specialty clothing store
Current assets	$    45,000.00	$ 150,000.00
Inventory (included above)	$    30,000.00	$ 125,000.00
Current Assets excluding Inventory	$    15,000.00	$    25,000.00
Current liabilities	$      9,000.00	$    85,000.00
Ratios
Current Ratio =
Current Assets / Current Liabilities	5	1.76
Quick Ratio=
(Current Assets - Inventories)/ Current Liabilities	1.67	0.29

Current Ratio :

This liquidity ratio provides a information regarding how quickly an entity can pay off its short Term obligations (ones due within a year). Higher the Ratio shows that the organisation can easily pay off its current liabilities .

The ideal current ratio is between 1.5 and 2 . However the industry standards too have to be verified.

Current Ratio Less than 1 is not favourable and is alarming.

Both the entities have Current ration higher than 1.5 , but Potz and Pan have very high ratio of 5.

Quick Ratio :

This liquidity ratio is an even better indicator of the organisations ability to pay off its short term liabilities. It shows the ability of the organisation to dispose of its current liabilities without having the requirement to sell its inventory or procuring aditional resources.

Higher the ratio , better the chances of the entity to pay off its obligations. The ideal Quick ratio is 1.

Wanna Bees have a very low quick ratio of 0.29 , where as Potz and Pan has a higher ratio.

An ideal observation would require further comparison of both the entities with the respective industry Standards too. But as the same is not available the observation cannot be made.

Based on the above observations Potz and Pan would be a better choice to lend money or to invest in.