Question

Carter Corporation financed construction of a new addition to its facilities with a large long-term note payable. As a condition of obtaining the loan, Carter agreed to maintain a current ratio at year-end of at least 1.7 to 1. If Carter fails to maintain this ratio, the lender may demand immediate repayment of the principal amount of the note and all unpaid accrued interest. As the end of the year approaches, Carter is concerned about the magnitude of its current ratio. Suggest some actions that the company might take to increase the magnitude of the current ratio.

Answer 1

Current ratio is liquidity ratio. It can also be stated as ratio which measures the ability of the firm to pay off its short term liability through its current assets.This ratio is used by investors to evaluate a firm's ability to pay its short-term debt obligations. It is extensively used by financial institutions and banks while giving loan to a business.

In the given case Carter is concerned about the magnitude of its current ratio. Few ways through which company can increase the magnitude of the current ratio are:

• It can delay any future capital purchases that would require cash payments. This will help Carter Corporation to have surplus cash at its disposal.
• Carter Corporation can sell any capital assets that are unproductive. This will increase the cash which can be used to reduce current debt, or else the money will be blocked unnecessarily.
• Now a days facility of sweeping are provided by many banks and financial institutions. This can help the organization to cut down on hard cash levels and keep money in bank accounts. This will fetch interest income on such funds while it is still available to to use when required.
• Carter Corporation can try to re-amortize its term loans.
• As drawings reduces the capital invested in the current assets, it thus increases the level of current liability to finance the current assets. Thus it should aim to reduce personal drawings on the business.
• It should try to achieve faster rolling of money via debtors . This will keep the current ratio in check. For this a constant follow up with the debtors is required to improve the collections.