Chapter 4: Working Capital and Current Ratio Notes

Working Capital and Current Ratio

Definitions

• Working Capital: Working capital is a financial metric that represents the difference between a company's current assets and current liabilities. It is a measure of a company’s liquidity and operational efficiency.
  • Formula:
    $\text{Working Capital} = \text{Current Assets} - \text{Current Liabilities}$
• Current Ratio: The current ratio is a liquidity ratio that measures a company's ability to pay short-term obligations or those due within one year. It compares current assets to current liabilities.
  • Formula:
    $\text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}}$

Data Presented

• Current Assets for HQ Properties Company:

  • 2019: $2,175,000
  • 2018: $1,900,000

• Current Liabilities for HQ Properties Company:

  • 2019: $1,500,000
  • 2018: $1,250,000

Calculations

a. Determine Working Capital and Current Ratio for 2019 and 2018

1. 2019 Calculations:

   • Calculate Working Capital:
     • $\text{Working Capital}_{2019} = 2,175,000 - 1,500,000 = 675,000$
   • Calculate Current Ratio:
     • $\text{Current Ratio}_{2019} = \frac{2,175,000}{1,500,000} = 1.45$

2. 2018 Calculations:

   • Calculate Working Capital:
     • $\text{Working Capital}_{2018} = 1,900,000 - 1,250,000 = 650,000$
   • Calculate Current Ratio:
     • $\text{Current Ratio}_{2018} = \frac{1,900,000}{1,250,000} = 1.52$

Results

• 2019:
  • Working Capital: $675,000
  • Current Ratio: 1.45
• 2018:
  • Working Capital: $650,000
  • Current Ratio: 1.52

Analysis of Change in Current Ratio

• The change in the current ratio from 2018 (1.52) to 2019 (1.45) indicates a decline in liquidity, which can be interpreted as an unfavorable change in the company's financial health. This suggests that the company has a slightly decreased ability to cover its short-term liabilities with its short-term assets.