Question

Below are some financial ratios of a firm:

Current ratio: 1.33

Acid Test ratio: 0.79

Inventory Turnover Ratio: 6.91

Provide a brief interpretation of this information.

Answer 1

1) Current ratio - 1.33

Meaning- Current ratio is a ratio which checks the liquidity of the firm in order to meet the short term liabilities. A current ratio is calculated by dividing the current assets by current liabilities. The ratio of 1.33 means that current assets is 1.33 times of the current liabilities, in other words there is sufficient current asset to meet the current liabilities of the company. The best current ratio is between 1.2 to 2.

2)Acid test ratio - 0.79

Meaning- Acid test ratio is also called quick ratio, which measures the liquidity of the company to meet immediate short term liabilities . This ratio is calculated by dividing current assets/ current liabilities . The current assets in this case only those assets which could be easily converted to cash. The higher the ratio the better it is. An acid ratio of 0.79 indicates that the firm doesn't have enough current assets to meet it's current liabilities. Hence, acid test ratio or liquidity position to meet the current liabilities is not good.

3) Inventory Turnover ratio - 6.91

Meaning- Inventory turnover ratio is an activity ratio which shows how many times the company sells its goods and gets new stock in a specific period. This ratio is calculated by dividing cost of goods sold by average inventory. The ratio of 6.91 indicates that company sells of its goods really fast and replaces with new stock aapproximately 7 times in a specified period. This shows that the demand for product exists. The higher the ratio the better it is for the firm as it will sell more.