Question

Read the situation below and participate in the forum answering as requested.

• The ABX company applied for a line of credit to finance the production operations of a new article. The bank denied the request because in its analysis of the financial statements the current ratio was less than 2.

2. Answer the following question:

Why do you think the bank considered that the current rate less than 2 was not adequate? What other factors could be considered when evaluating a current rate less than 2 as adequate?

3. In preparing your answer, explain what the current rate of a company measures and its importance for effective financial planning.

That is the only information that I have been provided. Many thanks if you are able to help me.

Answer 1

Facts of the Case: As the current ratio is less than 2, the standard and ideal ratio, ultimately decline the credit granting to the corporate.

Issue: The decision of FI is adequate over the decline of Credit on the basis of CR factor inadequacy only. Other factors to be considered.

Response: Current ratio is the ratio of Current Assets divided by current liabilities. It means that company is able to meets its current liability with ease as and when required. The ideal CR is determined as 2:1. Over -elaboration of ideal ratio it means Current ratio is 2 times greater than current liabilities.

It is effective factor for making decision about the company because, it shows the availability of liquidity of cash within the company, If we tend to determine the quick ratio in relation to current ratio it will reveal the truthiness about the flow of cash within the company in transparent way.

Because Quick ratio is nothing further extension of testing of the cash flow within the organization. The Quick ratio simply set aside the stock from the current assets, it reveal out the turnover of inventory as well as collection of debtors, as all inventory, receivable and cash are interlinked to each other.

Secondly, As discussed other factors Quick ratio as well as Inventory and debtor collection ratio shall be taken care off. Apart from this the Debt service coverage ratio, the profit % is able to cover the installments which falls due to availability of loan.

Conclusion: Thus from above it is apparent that the decision of the bank over the decline solely on the basis of CR ratio is not justified but however, the other ratio must be require dto be evaluated as stated above in the paragraphs, even if they also seems inappropriate and inadequate then the action of decline or rejection is the perfect decision in the above stated scenario.