Accounting: What the Numbers Mean 9th Edition by Wayne W McManus, Daniel F Viele, David H Marshall

Exercise 23

Effect of transactions on working capital and current ratio Management of Rivers Co. anticipates that its year-end balance sheet will show current assets of $12,639 and current liabilities of $7,480. Management is considering paying $3,850 of accounts payable before year-end even though payment isn’t due until later.

Required:

a.Calculate the firm’s working capital and current ratio under each situation. Would you recommend early payment of the accounts payable? Why? Round your current ratio answer to two decimal places.

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b. Assume that Rivers Co. had negotiated a short-term bank loan of $5,000 that can be drawn down either before or after the end of the year. Calculate work­ing capital and the current ratio at year-end under each situation, assuming that early payment of accounts payable is not made. When would you recom­mend that the loan be taken? Why? Round your current ratio answer to two decimal places.

Step 1 of 4

Current ratio:

It is a ratio which measures the liquidity and efficiency of a company. It is an indicator of a company’s ability to pay off its short-term liabilities.

Working capital:

It is the capital invested in a business which is available for the day to day working. It is calculated by subtracting current liabilities from current assets.