Question

2.You are analyzing the financial condition of a company to assess its ability to meet upcoming loan payments. You calculate its current ratio as 1.2. You also find that a major portion of accounts receivable is due from one client who has not made any payments in the past 12 months. Remov- ing this receivable from current assets lowers the current ratio to 0.7. What do you conclude?

Answer 1

Current ratio is calculated by diving current assets by current liabilites.

Conclusion:

If the major accounts recievable seems to be turned into bad debt, which is making the current ratio to fall to 0.7 is a big problem. This implies that company would be unable to pay its liabilities from its assets. Current ratio falls below 1 when its current liabilties are more than the current assets.

Basic undelying is that, if there is any risk or loss at the business, the company should be able to pay what it owes from what it owns. However, if the assets are less, then it will not be possible.