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    Analysis of Given Ratios - Picasso Company

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    Picasso Company is a wholesale distributor of professional equipment and supplies. The company's sales have averaged about $900,000 annually for the 3-year period 2006-2008. The firm's total assets at the end of 2008 amounted to $850,000. The president of Picasso Company has asked the controller to prepare a report that summarizes the financial aspects of the company's operations for the past 3 years. This report will be presented to the board of directors at their next meeting.

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    Answer: a)

    Both, the current ratio and the acid-test (quick) ratio are what are known as liquidity ratios, which are indicators of a firm's ability to meet its short-term financial obligations.

    The current ratio is the ratio of current assets to current liabilities:

    Current Ratio = Current Assets / Current Liabilities

    A high current ratio symbolizes that a company has most of its assets in liquid (readily convertible to cash) form. Short-term creditors prefer to deal with companies with a high current ratio since it reduces their risk. A low current ratio is a signal to company shareholders that the organization is effectively using its assets to grow the business.

    An advantage of the quick ratio is that it does not include current inventory items (i.e., cash, accounts receivable, and notes receivable) in its determination of a firm's liquidity. The quick ratio often referred to as the "acid-test," is defined as follows:
    Quick Ratio = (Current Assets - Inventory) / Current Liabilities)

    If a firm's current ratio is increasing while the ...

    Solution Summary

    This file contains a MS file containing the meaning of, and instructions for use of the various financial ratios that are used to determine the financial condition and past performance of an organization.