Assume that the current ratio for Arch Company is 2.0, its acid- test ratio is 1

Question

Assume that the current ratio for Arch Company is 2.0, its acid- test ratio is 1.5, and its working capital is $ 300,000. Answer each of the following questions independently, always referring to the original information.

a. How much does the firm have in current liabilities?
b. If the only current assets shown on the balance sheet for Arch Company are Cash, Accounts Receivable, and Merchandise Inventory, how much does the firm have in Merchandise Inventory?
c. If the firm collects an account receivable of $ 100,000, what will its new current ratio and working capital be?
d. If the firm pays an account payable of $ 100,000, what will its new current ratio and working capital be?
e. If the firm sells inventory that was purchased for $ 50,000 at a cash price of $ 60,000, what will its new acid- test ratio be?

Explanation / Answer

Current Assets - Current Liabilities = Working Capital ($300,000) And: Current Assets / Current Liabilities = Current Ratio (2.0) By looking at the current ratio you can see that current assets are 2.0 times current liabilities. So let current liabilities equal x and and current assets equal 2.0x. Then insert those amounts into the working capital formula and solve. 2.0x - x = 300,000 1x = 300,000 x = 300,000 current liabilities 2.0x = 600,000 current assets Now you can use the acid-test ratio to calculate inventory. (current assets - inventory) / current liabilities = 1.5 (600,000 - inventory) / 300,000 = 1.5 600,000 - inventory = 450,000 Inventory = 150,000 If the firm collects an account receivable of $100,000, what will its new current ratio and working capital be? You would just be exchanging one current asset (accounts receivable) with another (cash). Both amounts will remain the same. If the firm pays an account payable of $100,000, what will its new current ratio and working capital be? Current assets and current liabilities will both decrease by 100,000, so working capital will remain the same. The current ratio will be: 500,000 / 200,000 = 2.50 If the firm sells inventory that was purchased for $50,000 at a cash price of $60,000, what will its new acid-test ratio be? Current assets will increase by 60,000 - 50,000 = 10,000 Inventory will decrease by 50,000 (610,000 - 100,000) / 310,000 = 1.64 acid test ratio

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