Question 2 (4%)
The following items have been pulled from the Income Statement and the Balance Sheet.
Use the data to calculate the ratios below and compare them to the industry.
The ratio is "better" or "worse" is insufficient, tell me why.
Balance Sheet Items Income Statement Items
Inventory 1,000 Sales 15,000
Accounts Receivable 2,000 Credit Sales 13,500
Current Assets 5,000 Cost of goods sold 5,000
Total Assets 10,000
Current Liabilities 3,500
Common Equity 5,500 Net Income 1,800
Industry Avg Compared to the Industry
Acid Test Ratio 1.50
Average Collection Period 48 days
Total Asset Turnover 2.00
Return on equity 25%
Acid test ratio = (Current assets - Inventory)/Current liabilities = (5,000-1,000)/3,500 = 1.14
The industry average is 1.50
The acid test ratio measures the liquidity of the firm - the ability to pay the liabilities from the quick assets (cash, receivables, marketable securities). A higher ratio is better since it implies that quick assets are more than the current liabilities. In this case the company ratio is less than industry average and ...
The solution explains the calculation of some ratio and explains if they are better or worse as compared to industry