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College Accounting, Chapters 1-27

23rd Edition
HEINTZ + 1 other
ISBN: 9781337794756

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BuyFindarrow_forward

College Accounting, Chapters 1-27

23rd Edition
HEINTZ + 1 other
ISBN: 9781337794756
Textbook Problem

A friend of yours has the opportunity to invest in a small business. She has come to you for advice on how she might determine whether this would be a good investment. In particular, she is concerned about how long it takes to sell the merchandise and collect receivables. Draft a memo suggesting various ratios that should be computed to evaluate the business’s profitability, ability to pay its current obligations, and time required to sell inventory and collect receivables.

To determine

Draft a memo suggesting various ratios that should be computed to evaluate the profitability of business, ability to pay current obligations, and time required to sell inventory and collect receivables.

Explanation

Memo

From

ABC

To

XYZ

Re:  Suggestion regarding evaluation of businesses’ profitability, ability to pay current obligations, and time required to sell inventory and collect receivables

XYZ,

In order to take decision regarding the investment in a small business, evaluate profitability of business, to analyze the ability of paying current obligations, and time taken to sell inventory and collect receivables, following ratios must be computed:

 Working capital:

Working capital is a measure which evaluates the ability of a company to pay off the short-term debt obligations, by computing the excess of current assets over current liabilities is referred to as working capital. Therefore it is one of the measures of liquidity and it is an incorrect option.

 Current ratio:

The financial ratio which evaluates the ability of a company to pay off the debt obligations which mature within one year or within completion of operating cycle is referred to as current ratio. Therefore it is one of the measures of liquidity and it is an incorrect option.

 Quick ratio:

The financial ratio which evaluates the ability of a company to pay off the instant debt obligations is referred to as quick ratio...

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