These selected condensed data are taken from recent balance sheets of Bob Evans

Question

These selected condensed data are taken from recent balance sheets of Bob Evans Farms (in thousands).

   2005               2004

Cash                                                  $   5,267         $   3,986

Accounts receivable                           25,330            22,282

Inventories                                           24,416            19,540

Other current assets                             2,226              1,664

Total current assets                         $ 57,239         $ 47,472

Total current liabilities                     $188,628       $145,847

Instructions

Compute the current ratio for each year and comment on your results.

Compute the quick (acid test) ratio for each year and comment on your results.

Explanation / Answer

cuurent ratio = current Assets/current liabilities

a)for 2005 current ratio = 57239/188628 = 0.303

for 2004 CR = 47,472/145,847 = 0.325

The ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it will go bankrupt - as there are many ways to access financing - but it is definitely not a good sign.

b) quick (acid test) ratio

= current assets-inventories/current liabilities

for 2005 = 57,239-24,416/188,628 = 0.174

for 2004 = (47,472-19,540)/145,847 = 0.191

The quick ratio is more conservative than the current ratio, a more well-known liquidity measure, because it excludes inventory from current assets. Inventory is excluded because some companies have difficulty turning their inventory into cash. In the event that short-term obligations need to be paid off immediately, there are situations in which the current ratio would overestimate a company's short-term financial strength.

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