Page 193 - Calculating Agriculture Cover 20191124 STUDENT - A

CH 21] Calculating Agriculture 21-5

Quick Assets
Acid-Test Ratio = —————————
Current Liabilities

This is an important supplement to the current ratio because it indicates the company's
ability to meet current obligations. When the quick assets are less than current liabilities, the
company may experience difficulty in converting the non-quick assets if it must do so to meet
current debts. A ratio of 1:1 is considered to be the minimum.
Quick assets would include Cash, Cash Equivalents, Short Term Investments and Accounts
receivables. As such the Acid-Test Ratio becomes
Cash + Cash Equivalents + Short Term Investments + Current Receivables
Acid-Test Ratio = —————————————————————————————————————
Current Liabilities

Although there is no definite standard, an acid-test ratio in excess of 1:1 is usually
considered to be satisfactory.
Example A: Dunbar is applying for a loan with his local bank for new construction. The bank
asks for a balance sheet, Figure 21.1, to analyze his current debt levels. His
balance sheet reports $18,000 cash and $324,000 accounts receivable. His current
liabilities are $158,200. (a) What is Dunbar’s Acid-Test ratio, and (b) is this
sufficient to satisfy the banks desired ratio of 1:1?
21
Solution algorithm:

Cash + Cash Equivalents + Short Term Investments + Current Receivables
Acid-Test Ratio = ————————————————————————————————————- Short term
Current Liabilities investment:
Usually an
$18,000 + 0 + $324,000 + 0 investment of 5
(a) Acid-Test Ratio = ————————————— = 2.16:1
$ 158,200 years or shorter.
The returns
(b) Yes, the Dunbar ratio exceeds the desired minimum ratio for the bank of 1:1. should easily
convert to cash
Inventories of raw materials, work in process, growing animals for sale, and finished goods when the time is
(or merchandise) often represent a large portion of total current assets. A considerable amount of right. Examples
time may be required to convert inventories into cash in the normal operating processes. There is of short term
also the possibility of declines in market prices and a reduction in demand, both of which will investments are
adversely affect the ability to pay current liabilities. The acid-test ratio gives recognition of these high-yield
factors. savings
accounts,
Sometimes company financial statements don’t give a breakdown of quick assets on Certificates of
the balance sheet. In this case the quick ratio is used even if some of the quick asset totals are Deposit, money
unknown. Simply subtract inventory and any current prepaid assets from the current asset total market accounts,
for the numerator. The equation is: treasury bills,
and government
Total Current Assets – Inventory – Prepaid Expenses
Quick Ratio (Acid Test Ratio) = —————————————————————————— bonds.
Current Liabilities

Using the Dunbar Cattle Company Balance Sheet information from Figure 21.1, the quick ratio is
calculated as:

$645,000 – $300,000 – $3,000 $342,000
Quick Ratio = ——————————————— = ———— = 2.16 : 1
$158,200 $158,200

Example B: Van Dam Seed & Feed is applying for a loan to complete some store remodeling.
The bank asks for their most recent balance sheet to calculate the quick ratio. (a)
What is Van Dam’s Quick Ratio, and (b) and is it sufficient to satisfy the banks
desired ratio of 1:1? Newell’s Feed and Supply included the following accounts:

Cash: $20,000
Accounts Receivable: $12,000
Inventory: $11,000
Stock Investments: $ 2,000
Prepaid Taxes $ 1,000
Current Liabilities: $30,000

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