Chapter 12
Using Accounting Information
366
This cash can be invested in shares of other companies.The accounting for short-term investments
is beyond the scope of this course.
In essence, the quick ratio assesses the ability of the business to meet its most immediate debt
obligations without relying on the liquidation of inventory (which may take some time to sell).
A quick ratio of 1 indicates that the business has just enough liquid assets to pay for its current
liabilities. Anything below 1 might mean the business has too much of its money tied up in
inventory or other less liquid assets and may be unable to pay its short-term bills.
Quick ratios have been calculated using the numbers from Second Cup’s balance sheet in Figure
12.15. Note that Second Cup does not have any short-term investments.
2014
2013
Cash + Short-Term Investments +
Accounts Receivable
$14,944
$10,869
Current Liabilities
$23,684
$11,061
Quick Ratio
0.63
0.98
_______________
Figure 12.15
Notice that the quick ratio has decreased from 2013 (0.98) to 2014 (0.63). This means that the
company has gone from a nearly adequate short-term liquidity position to a dangerous one.
To address any potential problems here, and since the balance sheet provides only a snapshot of
business finances, further analyses should be performed over the course of the next few months
on the specific assets and liabilities of the business.This is to ensure that bills can be paid on time.
This situation could have worsened due to too much money being invested in inventory or fixed
assets. A review should be performed to address the situation and rectify any problems found.
Profitability Analysis
Profitability
refers to the ability of a company to generate profits.The greater the profitability, the
more valuable the company is to shareholders. A consistently unprofitable company is likely to go
bankrupt.There are several ratios available to help analyze the profitability of a company.They are
calculated using figures from the income statement as opposed to the balance sheet. The income
statement for Second Cup is shown in Figure 12.16.There are several revenues and expenses listed
which you may have never seen before, but we will focus on the analysis of the statement as a whole
rather than on individual accounts.
