Financial Statement Analysis - Case Study Example

CURRENT RATIO AND QUICK RATIO Computation of Liquidity Ratios for AutoZone Inc. (a) Current Ratio = Current Assets Current Liabilities Current Assets of AutoZone as on 30-Aug-2008:AssetsAmount ($)Cash and Cash Equivalents242,461Short term Investments-Net Receivables71,241Inventory2,150,109Other Current Assets122,490Total Current Assets2,586,301Current Liabilities of AutoZone as on 30-Aug-2008:LiabilitiesAmount ($)Accounts Payable2,395,511Short term Debt15,917Other Current Liabilities107,892Total Current Liabilities2,519,320Current Ratio = 2,586,301 / 2,519,320 = 1.

03 times(b) Quick Ratio = Quick Assets / Current LiabilitiesQuick Assets = Total Current Assets - Inventory = 2,586,301 - 2,150,109 = $436,192Quick Ratio = 436,192 / 2,519,320 = 0.173 timesSignificance of Current Ratio and Quick Ratio: The current ratio is a reflection of the financial strength of a company. It is the number of times a company's current assets exceed its current liabilities, which is one of the indications of solvency of that business. It measures the ability of the business to pay its current liabilities.

The current ratio also shows the short-term financial position of the business. A common rule of thumb is that an ideal current ratio is 2 to 1, that is, current assets must be twice the current liabilities. For instance, AutoZone has a current ratio of 1.03 times as compared to its competitors Advance Auto Parts and Pep Boys having a current ratio of 1.37 and 1.35 respectively. This shows that the short-term financial position of Advance Auto Parts and Pep Boys is slightly better than that of AutoZone.

While a low current ratio shows that the short term financial position is endangered, a very high current ratio would indicate idleness of working capital. It would mean that cash is not being utilized in an optimal way. For example, the excess cash might be better invested in equipment. A current ratio can be improved by increasing current assets or by decreasing current liabilities. Acquiring a long-term loan instead of short-term debt, selling an idle or less useful fixed asset are some of the many ways of improving the current ratio.

The quick ratio (also called 'acid test ratio') indicates the liquidity of a business. The quick ratio looks only at a company's most liquid assets and compares them to current liabilities. It tests whether a business can meet its obligations even if adverse conditions occur. In general, quick ratios between 0.5 and 1 are considered satisfactory as long as the collection of receivables is not expected to slow. AutoZone has a very low quick ratio of 0.173 times. However, one must remember that to properly judge how well a company is performing, it is imperative that the company be compared to the performance of the industry in which it competes.

(http://www.esmalloffice.com/SBR_template.cfmDocNumber=PL12_1500.htm#Liquidity%20Ratios)BibliographyHow to analyze your business using financial ratios. 21 Feb 2009.