Question

J. Doe runs a business. His current ratio is 0.71. His debts to asset ratio is 0.38. His rate of return on equity is 2.5%. He estimates he could earn 4% on investments off-farm. What is the financial situation on this farm?

1. Good liquidity, good solvency, profitable
2. Good liquidity, weak solvency, not profitable
3. Weak liquidity, good solvency, profitable,
4. Weak liquidity, good solvency, not profitable
5. Good liquidity, weak solvency, profitable

J. Doe runs a business. His current ratio is 2.1. His debts to asset ratio is 0.22. His rate of return on equity is 4.5% He estimates he could earn 3% on investments off-farm What is the financial situation on this farm?

1. Good liquidity, good solvency, profitable
2. Weak liquidity, weak solvency, profitable
3. Weak liquidity, good solvency, profitable
4. Weak liquidity, good solvency, not profitable
5. Good liquidity, good solvency, not profitable

Answer 1

1. Answer: Option D

Current ratio = Current Assets / Current Liabilities

A current ratio of less than 1 means that the amount of current assets is less than current liabilities. Hence it indicates that the company may have problems to meet its current liabilities which in turn indicates weak liquidity.

Debt to asset ratio = Total Debt / Total Assets

A debt to asset ratio of less than 1 means that the amount of assets is more than the amount of debt owed by the company. This indicates that the company has good solvency as if needed, the amount of debt can be paid off by liquidating the assets.

Rate of return on equity is less than rate of return off-farm. This means that the company can earn more if it invests the money in investments off-farm. Thus we can conclude that financial statement of the farm is not profitable.

2. Answer: Option A

Current ratio = Current Assets / Current Liabilities

A current ratio of more than 1 means that the amount of current assets is more than current liabilities. Hence it indicates that the company is financially strong to meet its current liabilities which in turn indicates good liquidity.

Debt to asset ratio = Total Debt / Total Assets

A debt to asset ratio of less than 1 means that the amount of assets is more than the amount of debt owed by the company. This indicates that the company has good solvency as if needed, the amount of debt can be paid off by liquidating the assets.

Rate of return on equity is more than rate of return off-farm. This means that the company can earn more if it invests the money on the farm. Thus we can conclude that financial statement of the farm is profitable.