Question

3. For Evergreen Environmental Engineering (EEE), determine the working capital, current ratio, and acid-test ratio. Evaluate the company’s economic situation with respect to its ability to pay off debts.

EEE Balance Sheet Date ($1000s)

Cash $110,000

Securities 40,000

Accounts Receivable 160,000

Inventories 250,000

Prepaid Expenses 3,000

Accounts Payable 351,000

Accrued Expenses 89,000

Answer 1

Working capital (net) = current assets - current liabilities

Working capital (net) = (Cash + securities + A/R + Inventory + prepaid expenses) - (A/P + Accrued expenses)

Working capital (net) = (110000+40000+160000+250000+3000) - (351000+89000)

Working capital (net) = $123000 ($1000s)

Current ratio = current assets / current liabilities

Current ratio = (110000+40000+160000+250000+3000)/(351000+89000)

Current ratio = 1.279 or 1.28

Acid test ratio = (current asset – inventories)/current liabilities

Acid test ratio = (110000+40000+160000+3000)/(351000+89000)

Acid test ratio = .71

The company has positive net working capital that shows that current assets are higher than the current liabilities. But, the company has trapped its huge amount into the inventories. It has caused the acid-test ratio to be less than 1. It has negatively affected the debt paying capabilities of the company. Hence, even if the current ratio is 1.28, that is higher than 1, but it will not help much if bigger amount is trapped in inventory. It will create cash crunch situation and poor debt service capabilities of the firm even if the firm has positive working capital and current ratio of more than 1.