A construction company shows current assets of $150,000 and current liabilities of $90,000. What does this indicate about the company's short-term financial health?
Correct Answer
D) Adequate liquidity with a current ratio of 1.67
Current ratio = Current Assets ÷ Current Liabilities = $150,000 ÷ $90,000 = 1.67. A ratio above 1.0 indicates the company can meet short-term obligations.
Why This Is the Correct Answer
The current ratio is calculated by dividing current assets by current liabilities ($150,000 ÷ $90,000 = 1.67). A current ratio above 1.0 indicates that the company has sufficient current assets to cover its current liabilities, demonstrating adequate liquidity. A ratio of 1.67 means the company has $1.67 in current assets for every $1.00 of current liabilities, which is considered healthy for short-term financial obligations. This level provides a reasonable cushion for meeting immediate debts and operational expenses.
Why the Other Options Are Wrong
Option A: Poor liquidity with a current ratio below 1.0
Option A is incorrect because the current ratio is 1.67, which is well above 1.0, not below it. A ratio above 1.0 indicates good liquidity, not poor liquidity.
Option B: Insufficient information to determine liquidity
Option C is wrong because while the company has more assets than liabilities, a 1.67 ratio is not excessive - it's actually a healthy balance. Construction companies need adequate cash flow for materials, payroll, and unexpected expenses.
Memory Technique
Think 'Current = Cash flow' - if you have more current assets than current liabilities, your cash can flow to pay bills. The ratio tells you how many dollars of assets per dollar of debt.
Reference Hint
Business and Finance chapter, specifically the section on Financial Ratios and Liquidity Analysis
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