Question 1
Multiple ChoiceData for Riverbend Tools Ltd. are presented in the following table:
As of 31 December | £ Thousands |
|---|---|
Cash | 150 |
Accounts receivable | 400 |
Inventory | 1,000 |
Accounts payable | 250 |
Wages payable | 100 |
Short-term loan payable (due in two equal annual payments, first due in 6 months) | 300 |
The current ratio for the firm’s industry is 3.0. Based on the current ratio, Riverbend Tools' liquidity compared with the industry is best described as being:
Explanation
Step 1: What is the current ratio?
The current ratio shows how well a company can pay its short-term debts using its short-term assets.
Formula:
Current Ratio = Current Assets ÷ Current Liabilities
Step 2: What are Riverbend’s current assets?
These are things the company expects to turn into cash soon:
Cash = £150
Accounts receivable = £400 (money customers owe)
Inventory = £1,000 (goods to sell)
Total current assets = 150 + 400 + 1,000 = £1,550
Step 3: What are Riverbend’s current liabilities?
These are short-term debts the company must pay within a year:
Accounts payable = £250 (money owed to suppliers)
Wages payable = £100 (money owed to employees)
Short-term loan payment = £150 (the first half of a 2-year loan)
Total current liabilities = 250 + 100 + 150 = £500
Step 4: Calculate Riverbend’s current ratio
Current Ratio = £1,550 ÷ £500 = 3.1
Step 5: Compare to the industry average
Riverbend’s current ratio = 3.1
Industry average = 3.0
Since 3.1 is higher than 3.0, Riverbend has more liquidity than the average company in its industry.