CSLB Law & Business ExamBusiness FinancesMedium
A contractor is reviewing the company's financial health and wants to assess its ability to meet short-term obligations using its most liquid assets. The company has cash of $15,000, accounts receivable of $25,000, inventory of $30,000, and current liabilities of $40,000. What is the company's quick ratio (acid-test ratio)?
- A1.00
- B2.00
- C0.80
- D1.75
Show answer & explanationAnswer & explanation
Correct answer: A. 1.00
The quick ratio is calculated as (Cash + Accounts Receivable) / Current Liabilities. So, ($15,000 + $25,000) / $40,000 = $40,000 / $40,000 = 1.00.
Why the other options are wrong
- B. This is an incorrect calculation that does not align with the quick ratio formula.
- C. This result would be obtained if only cash was considered, or if there was an error in calculation.
- D. This would be the current ratio, which includes inventory ($15,000 + $25,000 + $30,000) / $40,000 = 1.75.
Quick Ratio (Acid-Test Ratio)
The quick ratio measures a company's ability to meet its short-term obligations with its most liquid assets (excluding inventory). It is a more conservative measure than the current ratio.
- Formula: (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities
- Excludes inventory due to its lower liquidity
- A ratio of 1.0 or higher is generally considered healthy
Memory trick: Quick Ratio: Cash and Receivables, minus the 'slow' inventory, over liabilities, for a 'quick' check.