Question

Quick Ratio

Calculate the quick ration for Smith & Sons Inc for 2015 and 2016 and comment on the company’s working capital position. Did the company’s ability to pay its current liabilities improve over the two years?

Quick ratio = (cash and cash equivalents + Short term investments + Accounts receivable)/Current Liabilities

Smith & Sons, Inc
Balance Sheet
Decemober 31, 2016 and 2015
(In millions)		2016	2015
Assets
Current assets
Cash and cash equivalents		200	400
Accounts receivable		900	800
Inventory		500	650
Other Current assets		400	250
Total Current assets		2000	2100
Property, plant & equipment (net)		2,600	2,500
Other Assets		5,700	5,900
Total assets		10,300	10,500
Labilities and Stockholders'e Equity
Current Liabilites		3,000	2,900
Long-term liabilities		5,000	5,400
Total Labilities		8,000	8,300
Stockholders's equity-common		2,300	2,200
Total Labilities and Stockholders' Equity		10,300	10,500

Answer 1

Calculatio of the quick ratio for Smith & Sons Inc for 2015 and 2016

Ans Quick Ratio Or Acid Test Ratio measures the liquidity of the firm. It basically measures the company's ability to meet the current liabilities of the firm on a very short basis. It is an indicator of short term solvency of the company.The quick assets are those assets which can be easily converted into cash within a short period of time.

Quick Ratio = Cash and Cash Equivalents + Short Term Investments + Accounts Receivables    ÷ Current Laibilities

Quick Ratio for 2015 = $ 400 + $ 250 + $ 800 / $ 2900 = 0.5 : 1

Quick Ratio for 2016 = $ 200 + $ 400 + $ 900 / $ 3000 = 0.5 : 1

i) Assuming that other current assets are convetible into cash within short period of time. I have considered them to calculate quick ratio. Now considering the assumption there is no difference in the quick ratio which means neither any improvement is made not it has detoriated. Altough a quick ratio of 0.5 : 1 indicated that the firm is able to meet only 50 % of its liabilities by utilising its quick assets. The quick ratio is constant due to the fact that altogether quick assets increased by $ 100 million and current liabilites is also increased by the exact same amount.

ii) If you want you can assume otherwise that other current assets are not easily converted into cash, may be they include prepaid expense or deferred revunue which are not quick asset. Then the quick ratio will differ as calculated below:

Quick Ratio for 2015 = $ 400 + $ 800 / $ 2900 = 0.41 : 1

Quick Ratio for 2016 = $ 200 + $ 900 / $ 3000 = 0.37 : 1

Considering the assumption made in (ii) above the quick ratio has deteriorated wihin two years. A ratio of 0.41:1 in 2015 indicates that only 41 % of total current liabilites can be met by utilising the quick assets of the firm. And 2016 it ratio further fell to 0.37:1 indicating that now only 37 % of total current liabilities can be met by utilizing the quick assets of thefirm. This has happened due to the fact that cash and cash equivalent has decresed by almost 50 % in 2016.

Now coming to working capital it measures the company's ability to maintain its operational efficiency and short term financial health. A positive working capital indicates that company has enough fund to meet its currents liabilities. While a negative working capital indicate that company is struggling to meet is short term debt obligations.

Working capital (2015) = Currents Assets Less Current Liabilities

= $ 2100 - $ 2900

=( $ 800 millions )

Working Capital ( 2016 ) = $ 2000 - $ 3000

= ( $ 1000 millions )

The position of company working capital is not at all healthy as in 2015 it has a negative working capital of $ 800 millions and then in 2016 it further got detoriorated by falling to negative $ 1000 millions.This indicates that company has trouble in meeting its short-term liabilities with its current assets. And it needs raise funds in order to be operational. So that it could maintain its operational efficiency.

Did the company’s ability to pay its current liabilities improve over the two years?

No not at all. In fact the company's ability to meet its current liabilities has deteriorated over the two as its quick ratio which was 0.5 in 2015 considering the assumption made in (i) above has remained constant in 2016 instead of improving. And it working capital has worsen in 2016 due to the fact that current assets decreased by $ 100 millions and current liabilities increased by $ 100 millions. Both having a negative impact on working capital of the frim