Page 683 - Accounting Principles (A Business Perspective)

17. Analysis and interpretation of financial statements

Refer to Exhibit 133. The Synotech data in Column (4) indicate that current liabilities are increasing more
rapidly than current assets. We could also make such an observation directly by looking at the change in the current
ratio. Synotech's current ratios for 2010 and 2009 follow:

December 31
(USD millions) 2010 2009 Amount of
increase
Current assets (a) $2,846.7 $,2832.4 14.3
Current liabilities (b) 2,285.6 2,103.8 181.4
Working capital (a – b) $ 561.5 $ 728.6 $(167.1)
Current ratio (a/b) 1.25:1 1.35:1
Synotech's working capital decreased by USD 167.1 million, or 22.9 per cent (USD 167.1/USD 728.6), and its
current ratio decreased from 1.35:1 to 1.25:1. Together, these figures reflect that its current liabilities increased
faster than its current assets.
Acid-test (quick) ratio The current ratio is not the only measure of a company's short-term debt-paying
ability. Another measure, called the acid-test (quick) ratio, is the ratio of quick assets (cash, marketable
securities, and net receivables) to current liabilities. Analysts exclude inventories and prepaid expenses from

current assets to compute quick assets because they might not be readily convertible into cash. The formula for the
acid-test ratio is:
Quickassets
Acid−test ratio=
Current liabilities
Short-term creditors are particularly interested in this ratio, which relates the pool of cash and immediate cash

inflows to immediate cash outflows.
The acid-test ratios for 2010 and 2009 for Synotech are:
December 31
(USD millions) 2010 2009 Amount of
increase or
(decrease)
Quick assets (a) $1,646.6 $1,648.3 $ (1.7)
Current liabilities (b) 2,285.6 2,103.8 181.8
Net quick assets (a – b) $ (639.0) $ (455.5) $(183.5)
Acid-test ratio (a/b) .72:1 .78:1
In deciding whether the acid-test ratio is satisfactory, investors consider the quality of the marketable securities
and receivables. An accumulation of poor-quality marketable securities or receivables, or both, could cause an acid-

test ratio to appear deceptively favorable. When referring to marketable securities, poor quality means securities
likely to generate losses when sold. Poor-quality receivables may be uncollectible or not collectible until long past
due. The quality of receivables depends primarily on their age, which can be assessed by preparing an aging
schedule or by calculating the accounts receivable turnover. (Covered in Chapter 9.)
Cash flow liquidity ratio Another approach to measuring short-term liquidity is the cash flow liquidity
ratio. The numerator, as an approximation of cash resources, consists of (1) cash and marketable securities, or
liquid current assets, and (2) net cash provided by operating activities, or the cash generated from the company's
operations. This reflects the company's ability to sell inventory and collect accounts receivable. The formula for the
cash flow liquidity ratio is:

Cash alsomarketable securitiesNetcash provided byoperatingactivities
Current liabilities

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