The current ratio equals current assets divided by current liabilities. Cardinal Corporation has a current ratio of 0.95. The industry average current ratio is 1.89. Cardinal Corporation appears to have __ relative to its industry peers.
a.
good investment value
b.
poor profitability
c.
short-term liquidity problems
d.
long-term solvency problems
e.
low stock market value
The Correct Answer and Explanation is:
Correct Answer: c. short-term liquidity problems
Explanation:
The current ratio is a key financial metric that measures a company’s ability to pay off its short-term liabilities with its short-term assets. It is calculated using the formula: Current Ratio=Current AssetsCurrent Liabilities\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}
A current ratio below 1.0 indicates that a company does not have enough short-term assets to cover its short-term liabilities, which raises concerns about its liquidity position. In other words, if all current liabilities were to come due at once, the company might struggle to pay them using its current assets.
In this scenario, Cardinal Corporation has a current ratio of 0.95, which means for every $1.00 of current liabilities, it only has $0.95 in current assets. This is below the industry average of 1.89, which implies that most of Cardinal’s peers have almost double the amount of current assets relative to their current liabilities. The industry benchmark suggests a healthier liquidity position among competitors.
This discrepancy suggests that Cardinal Corporation may face short-term liquidity problems. It may have difficulty paying off its obligations as they come due without selling long-term assets, borrowing funds, or delaying payments, all of which can be risky and costly.
It is important to note that the current ratio does not directly measure profitability, long-term solvency, investment value, or stock market valuation. Those aspects are better evaluated using other metrics like net profit margin, debt-to-equity ratio, price-to-earnings ratio, or market capitalization.
Therefore, the most accurate and relevant conclusion is that Cardinal Corporation has short-term liquidity problems relative to its industry peers, which could potentially impact its operations if not addressed.
