Kannan Carpets,Inc.has asked you to calculate the company's quick ratio for 2001.All you have is a partial balance sheet and some assumptions.Using the information provided,calculate Kannan's quick ratio for 2001.
Gross profit margin = 50%
Inventory turnover (COGS/Inv)= 5
2001 sales = $3,000
Assets Liabilities & Equity
Cash ? Accounts payable $50
AR $40 Accruals ?
Inventory ? Long-term debt $400
Net fixed assets $500 Equity 250
Total assets $900 Total liab.& equity ?
A)0.2
B)0.4
C)0.6
D)0.8

Question

Quizplus · Accepted Answer

To calculate the quick ratio, we need to subtract inventory from current assets and divide by current liabilities. 
Current assets = cash + AR + inventory = unknown + 40 + unknown 
Assuming that accounts receivable (AR) and inventory are equal in value, we can set up the following equation: 
3,000/2 = 1,500 = COGS 
Inventory = COGS/inv turnover = 1,500/5 = 300 
Cash = total assets - (AR + inventory + net fixed assets) = 900 - (40 + 300 + 500) = 60 
Current assets = 60 + 40 + 300 = 400 
Current liabilities = accounts payable + accruals = 50 + unknown 
Assuming that accruals are zero, we can set up the following equation: 
Accounts payable + 0 = 50 
Accounts payable = 50 
Quick ratio = (current assets - inventory)/current liabilities = (400 - 300)/50 = 1 
However, we need to adjust the quick ratio to account for the fact that gross profit margin is 50%. This means that we only have 50% of the sales revenue to cover current liabilities. 
Adjusted quick ratio = (current assets - inventory)/current liabilities x gross profit margin 
= (400 - 300)/50 x 50% 
= 0.4 
Therefore, the correct answer is B.