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# Introduction to Business - Essay Example

Summary
A better measure is acid-test ratio which takes into account the lesser liquid nature of the inventory and therefore it is preferred over current ratio, especially in the merchandizing business. (Brigham, 1985) In…

## Extract of sample "Introduction to Business"

INTRODUCTION TO BUSINESS Introduction to Business and Section # of Ratio Analysis Current ratio is a measure of assessing liquidity of the company. A better measure is acid-test ratio which takes into account the lesser liquid nature of the inventory and therefore it is preferred over current ratio, especially in the merchandizing business. (Brigham, 1985) In the exercise given, two companies have applied for the loan and thus based on their respective current ratios and acid test-ratios, the opinion will be formed regarding the more deserving candidate to receive the loan.
Current Ratio
Calculations: Current Ratio = Current Assets/Current Liabilities (Brigham, 1985)
Current Ratio of Potz = 45000/9000
Current Ratio of Potz = 5
Current Ratio of Wannabees = 150000/85000
Current Ratio of Wannabees = 1.765
Opinion
In the light of information above, Potz current ratio is approximately three times larger than that of the Wannabees. This implies that Potz’s assets are more likely to be converted into cash beforehand to that of the Wannabees. It is therefore believed that Potz possess lesser risk to the banks and thus suits more to their requirements to pay-off the loan. (Brigham, 1985)

Calculations: Acid-test Ratio = (Current Assets – Inventories)/Current Liabilities (Brigham, 1985)
Acid-test Ratio of Potz = (45000-30000)/9000 = 15000/9000 = 5/3
Acid-test Ratio of Potz = 1.667
Acid-test Ratio of Wannabees = (150000-125000)/85000 = 25000/85000 = 5/17
Acid-test Ratio of Wannabees = 0.294
Opinion
The calculations of the acid test ratio have only confirmed our opinion. It can be observed from the calculations above that Wannabee has too much cash entrapped in inventories which takes time to liquidate. (Brigham, 1985) On the other hand Potz, whose acid-test ratio is 5.7 times larger than that of the Wannabees, is more likely to attract the bank due to its ability to liquefy itself. Therefore, it is expected that the Potz is more likely to receive the loan due to its capacity to turn its assets into cash, which can be reflected in the calculations of their acid-test ratio.
Conclusion
Despite the fact that liquidity plays an important role in the bank’s decision to grant the loan but one cannot ignore the impact of the profitability, efficiency and leverage ratios in the process. However, if the best decision is to be based on the ratios given in the exercise then Potz is likely to succeed in the process.
References
Book
Brigham, E. F. et al (1985). Introduction to Financial Management. Dryden Press.
Van Horne, J. C. et al (1998). Fundamentals of Financial Managemen (11th Edition). Prentice Hall. Read More
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