DFS task 2.1 Dec08 suggestions for current ratios

Londina

There are these two ratios

2007 Current ratio 1.92
2008 Current ratio 2.35

2007 Quick ratio 0.72
2008 Quick ratio 1.37

Question:

(d) ONE suggestion as to how EACH of the ratios might be improved.[/I]

Answer for poind d):
The company has poorer liquidity this year than last.
The current ratio has fallen despite an increase in inventories which means a decrease in cash or near cash current assets.

The quick ratio shows relatively less quick assets to meet current liabilities. The main worry would seem to be the large increase in the overdraft.

From this answer I don't really see a suggestion, apart from repeat what the previous task asked ( (c)Comments on the relative performance of the company for the two years based on the ratios calculated)

Does somebody knows that has to be done to improve the ratios?

Steve Collings

Hi Londina,

With ratio analysis it is important to not only understand what it is the ratio is telling you (as well as being able to calculate it) but also what causes fluctuations in the ratio concerned. By understanding what causes these fluctuations, when it comes to suggesting solutions to detrimental fluctuations, you can then easily make the suggestions.

For example, the current ratio looks at a company's working capital and measures an entity's short term solvency. In other words it looks at how able an entity is to meet is short term obligations. Reductions in this ratio mean that the entity has less ability to generate cash (a possible solution could be to turn pending orders into sales).

The quick ratio is similar to the current ratio except it excludes inventory because inventory takes time to follow the 'order of liquidity' i.e. inventory to debtors then to cash. It could be that an entity has a stable current ratio but a declining quick ratio - in this instance the entity might be building up too much inventory so a solution would be to review buying policies/inventory holding policies.

Kind regards
Steve

CathG

I'm reading it the other way - liquidity has improved in 2008, going from 1.92 up to 2.35

Inventory holding must have decreased which has led to a higher quick ratio.

Londina

many thanks for the replies:001_smile:

Ampsie

Hi,

I've just done this paper. Got confused when i read your answer:

[HTML]2007 Current ratio 1.92
2008 Current ratio 2.35

2007 Quick ratio 0.72
2008 Quick ratio 1.37[/HTML]

These are the wrong way round - current ratio in 2007 is 2.35 and in 2008 1.92
quick ratio in 2007 is 1.37 and in 2008 is 0.72

This shows that liquidity has decreased. So one way of improving would be to hold less inventories.

Ampsie
Going into brain overload!
:001_smile: