Question

Texas Instrument Corp. has the following simplified balance sheet:

Cash                                        $ 50,000          Current liabilities                     $125,000

Inventory                               150,000

Accounts receivable               100,000           Long-term debt                      175,000

Net fixed assets                       200,000          Common equity                      200,000

Total                                        $500,000         Total                                        $500,000

Net Sales for the year totaled $600,000 and its gross profit is $100,000. The company president believes the company carries excess inventory. She would like the inventory turnover ratio to be 8 times and and would use the cash that we free up from reducing the inventory to meet the targeted inventory turnover to reduce current liabilities. If the company follows the president's recommendation and sales remain the same, what would new quick ratio be?

Answer 1

The new quick ratio is computed as follows:

Inventory is computed as follows:

= (Sales - gross profit) / Inventory turnover

= ($ 600,000 - $ 100,000) / 8

= $ 62,500

So, the new quick ratio will be as follows:

= (Cash + Accounts receivable) / (current liabilities - (Old inventory - New inventory) )

= ($ 50,000 + $ 100,000) / ($ 125,000 - ($ 150,000 - $ 62,500) )

= $ 150,000 / $ 37,500

= 4 times

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