Peak Performance Sporting Goods Company has just applied for a bank loan in order to expand the business. Using the most recent Balance Sheet data provided by the company owner, you calculate that the company's current ratio is 2.5. In your presentation to the company boss, you remark:
A)Peak Performance's is currently having trouble meeting its short-term obligations.
B)Peak Performance's has $2.50 that it owes each month, for every $1.00 of cash that it is generating.
C)Peak Performance has $2.50 of current assets for each $1.00 of currently liabilities.
D)Due to the fact that most of Peak Performance's current assets are tied-up in inventory, there is no need to worry about whether Peak

Question

Quizplus · Accepted Answer

The current ratio is calculated by dividing current assets by current liabilities, and a ratio of 2.5 indicates that Peak Performance has $2.50 of current assets for each $1.00 of current liabilities. This suggests that the company is in a good position to meet its short-term obligations. Option A is incorrect because a current ratio of 2.5 indicates the opposite - that the company is able to meet its short-term obligations. Option B is incorrect because it presents the ratio in reverse order, and also suggests that the company owes $2.50 for every $1.00 of cash generated, which is not an accurate representation of the ratio. Option D is incorrect because inventory is a part of current assets, and having a high inventory can actually be a concern if it is not being converted into cash quickly enough.

Peak Performance Sporting Goods Company Has Just Applied for a Bank