Question

Refer to Simon Company’s balance sheets in Exercise 13-6. Analyze its year-end short-term liquidity position at the end of 2017, 2016, and 2015 by computing

(1) the current ratio and

(2) the acid-test ratio.

Comment on the ratio results. (Round ratio amounts to two decimals.)

Short answer

1. The current ratio has declined from 2.87 to 1.88over three years.
2. Acid- test ratio has declined from 1.72 to 0.93over the three years.

Step-by-step solution

Meaning of Ratio Analysis

Ratio analysis is a basic approach toassessing a company's health by examining the relationships between key financial indicators. According to many analysts, ratio analysis is the most important aspect of the analytical process.

Determining the ratio

Calculating current ratio

2017

$\begin{array}{c}\mathbf{C}\mathbf{u}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{r}\mathbf{a}\mathbf{t}\mathbf{i}\mathbf{o}\mathbf{=}\frac{\mathbf{C}\mathbf{u}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{a}\mathbf{s}\mathbf{s}\mathbf{e}\mathbf{t}}{\mathbf{C}\mathbf{u}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{r}\mathbf{a}\mathbf{t}\mathbf{i}\mathbf{o}}\\ \mathbf{=}\frac{\mathbf{\$}\mathbf{31}\mathbf{,}\mathbf{500}\mathbf{+}\mathbf{\$}\mathbf{89}\mathbf{,}\mathbf{500}\mathbf{+}\mathbf{\$}\mathbf{112}\mathbf{,}\mathbf{500}\mathbf{+}\mathbf{\$}\mathbf{10}\mathbf{,}\mathbf{700}}{\mathbf{\$}\mathbf{129}\mathbf{,}\mathbf{900}}\\ \mathbf{=}\mathbf{1}\mathbf{.}\mathbf{88}\mathbf{\text{\hspace{0.17em}}}\mathbf{t}\mathbf{o}\mathbf{1}\end{array}$

2016

$\begin{array}{c}\mathbf{C}\mathbf{u}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{r}\mathbf{a}\mathbf{t}\mathbf{i}\mathbf{o}\mathbf{=}\frac{\mathbf{C}\mathbf{u}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{a}\mathbf{s}\mathbf{s}\mathbf{e}\mathbf{t}}{\mathbf{C}\mathbf{u}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{r}\mathbf{a}\mathbf{t}\mathbf{i}\mathbf{o}}\\ \mathbf{=}\frac{\mathbf{\$}\mathbf{35}\mathbf{,}\mathbf{625}\mathbf{+}\mathbf{\$}\mathbf{62}\mathbf{,}\mathbf{500}\mathbf{+}\mathbf{\$}\mathbf{82}\mathbf{,}\mathbf{500}\mathbf{+}\mathbf{\$}\mathbf{9}\mathbf{,}\mathbf{375}}{\mathbf{\$}\mathbf{75}\mathbf{,}\mathbf{250}}\\ \mathbf{=}\mathbf{2}\mathbf{.}\mathbf{55}\mathbf{t}\mathbf{o}\mathbf{1}\end{array}$

2015

$\begin{array}{c}\mathbf{C}\mathbf{u}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{r}\mathbf{a}\mathbf{t}\mathbf{i}\mathbf{o}\mathbf{=}\frac{\mathbf{C}\mathbf{u}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{a}\mathbf{s}\mathbf{s}\mathbf{e}\mathbf{t}}{\mathbf{C}\mathbf{u}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{r}\mathbf{a}\mathbf{t}\mathbf{i}\mathbf{o}}\\ \mathbf{=}\frac{\mathbf{\$}\mathbf{37}\mathbf{,}\mathbf{800}\mathbf{+}\mathbf{\$}\mathbf{50}\mathbf{,}\mathbf{200}\mathbf{+}\mathbf{\$}\mathbf{54}\mathbf{,}\mathbf{500}\mathbf{+}\mathbf{\$}\mathbf{5}\mathbf{,}\mathbf{000}}{\mathbf{\$}\mathbf{51}\mathbf{,}\mathbf{250}}\\ \mathbf{=}\mathbf{2}\mathbf{.}\mathbf{87}\mathbf{t}\mathbf{o}\mathbf{1}\end{array}$

Calculating Acid-test ratio

2017

$\begin{array}{c}\mathbf{A}\mathbf{c}\mathbf{i}\mathbf{d}\mathbf{-}\mathbf{t}\mathbf{e}\mathbf{s}\mathbf{t}\mathbf{r}\mathbf{a}\mathbf{t}\mathbf{i}\mathbf{o}\mathbf{=}\frac{\mathbf{Q}\mathbf{u}\mathbf{i}\mathbf{c}\mathbf{k}\mathbf{a}\mathbf{s}\mathbf{s}\mathbf{e}\mathbf{t}}{\mathbf{T}\mathbf{o}\mathbf{t}\mathbf{a}\mathbf{l}\mathbf{c}\mathbf{u}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{l}\mathbf{i}\mathbf{a}\mathbf{b}\mathbf{i}\mathbf{l}\mathbf{i}\mathbf{t}\mathbf{i}\mathbf{e}\mathbf{s}}\\ \mathbf{=}\frac{\mathbf{\$}\mathbf{31}\mathbf{,}\mathbf{800}\mathbf{+}\mathbf{\$}\mathbf{89}\mathbf{,}\mathbf{500}}{\mathbf{\$}\mathbf{129}\mathbf{,}\mathbf{900}}\\ \mathbf{=}\mathbf{0}\mathbf{.}\mathbf{93}\mathbf{t}\mathbf{o}\mathbf{1}\end{array}$

2016

$\begin{array}{c}\mathbf{A}\mathbf{c}\mathbf{i}\mathbf{d}\mathbf{-}\mathbf{t}\mathbf{e}\mathbf{s}\mathbf{t}\mathbf{r}\mathbf{a}\mathbf{t}\mathbf{i}\mathbf{o}\mathbf{=}\frac{\mathbf{Q}\mathbf{u}\mathbf{i}\mathbf{c}\mathbf{k}\mathbf{a}\mathbf{s}\mathbf{s}\mathbf{e}\mathbf{t}}{\mathbf{T}\mathbf{o}\mathbf{t}\mathbf{a}\mathbf{l}\mathbf{c}\mathbf{u}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{l}\mathbf{i}\mathbf{a}\mathbf{b}\mathbf{i}\mathbf{l}\mathbf{i}\mathbf{t}\mathbf{i}\mathbf{e}\mathbf{s}}\\ \mathbf{=}\frac{\mathbf{\$}\mathbf{35}\mathbf{,}\mathbf{625}\mathbf{+}\mathbf{\$}\mathbf{62}\mathbf{,}\mathbf{500}}{\mathbf{\$}\mathbf{75}\mathbf{,}\mathbf{250}}\\ \mathbf{=}\mathbf{1}\mathbf{.}\mathbf{30}\mathbf{t}\mathbf{o}\mathbf{1}\end{array}$

2015

$\begin{array}{c}\mathbf{A}\mathbf{c}\mathbf{i}\mathbf{d}\mathbf{-}\mathbf{t}\mathbf{e}\mathbf{s}\mathbf{t}\mathbf{r}\mathbf{a}\mathbf{t}\mathbf{i}\mathbf{o}\mathbf{=}\frac{\mathbf{Q}\mathbf{u}\mathbf{i}\mathbf{c}\mathbf{k}\mathbf{a}\mathbf{s}\mathbf{s}\mathbf{e}\mathbf{t}}{\mathbf{T}\mathbf{o}\mathbf{t}\mathbf{a}\mathbf{l}\mathbf{c}\mathbf{u}\mathbf{r}\mathbf{r}\mathbf{e}\mathbf{n}\mathbf{t}\mathbf{l}\mathbf{i}\mathbf{a}\mathbf{b}\mathbf{i}\mathbf{l}\mathbf{i}\mathbf{t}\mathbf{i}\mathbf{e}\mathbf{s}}\\ \mathbf{=}\frac{\mathbf{\$}\mathbf{37}\mathbf{,}\mathbf{800}\mathbf{+}\mathbf{\$}\mathbf{50}\mathbf{,}\mathbf{200}}{\mathbf{\$}\mathbf{51}\mathbf{,}\mathbf{250}}\\ \mathbf{=}\mathbf{1}\mathbf{.}\mathbf{72}\mathbf{t}\mathbf{o}\mathbf{1}\end{array}$

Analysis

Over these three years, Simon's short-term cash situation has gotten worse. Declining trends are evident in both the current and acid-test ratios. The acid-test ratio changes from 1.72 to 1 down to 0.93 to 1, and the current ratio changes from 2.87 to 1 down to 1.88 to 1, both indicate a potential liquidity issue, even though we are unsure about the company's line of business. However, we must acknowledge that industry standards may demonstrate that the 2015 ratios were excessive (instead of the 2017 ratios being too low).