Current Ratio

1. Compute the current ratio, the amount of working capital, and other amounts pertinent to the reporting of accounts receivable.

2. Describe the meaning of the current ratio.

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3. Describe the meaning of the working capital balance.

4. Calculate the amount of time that passes before the average accounts receivable is collected and explain the importance of this information.

5. List techniques that an organization can implement to speed up the collection of accounts receivable.

Question: Many individuals analyze financial statements to make logical and appropriate decisions about a

company’s financial health and well being. This process is somewhat similar to a medical doctor performing

a physical examination on a patient. The doctor often begins by checking various vital signs, such as heart

rate, blood pressure, weight, cholesterol level, and body temperature, looking for any signs of a serious change

or problem. For example, if a person’s heart rate is higher than expected or if blood pressure has increased

significantly since the last visit, the doctor will investigate with special care.

In examining the financial statements of a business or other organization, are there vital signs that should be

studied as a routine matter?

Answer: Financial statements are extremely complex and most analysts have certain preferred figures or ratios

that they believe to be especially significant when investigating a company. For example, previously, the current

ratio and the amount of working capital were computed based on the amount of current assets (those that will be

used or consumed within one year) and current liabilities (those that will be paid within one year):

current ratio = current assets/current liabilities

working capital = current assets – current liabilities.

Both of these figures reflect a company’s ability to pay its debts and have enough monetary resources still

available to generate profits in the near future. Both investors and creditors frequently calculate, study, and

analyze these two amounts. They are vital signs that help indicate the financial health of a business or other