Question
The table below shows two liquidity ratios calculated for Dilva Ltd for the past two years: multicolumn(1)(|c|)( Ratio ) & 2022 & 2021 Current ratio & 1.6 & 1.2 Quick (acid) ratio & 1.3: & 1.1: Which of the following statements is an incorrect interpretation of these ratio The ratios indicate that the company has sufficient liquid assets to meet its shortterm obligations. In 2022, for every £ 1 of current liabilities, the company has £ 1.6 liquid assets and £ 1.3 current assets. There is no ideal current ratio that fits all businesses, different types of businesses in different sectors may require different current ratios. For a more stringent test of liquidity, inventory is excluded from the quick ratio calculation.
Answer
4.4
(262 Votes)
Bryn
Elite · Tutor for 8 years
Answer
Every interpretation given is accurate according to the provided liquidity ratios. There is no incorrect interpretation.
Explanation
## Step 1:Firstly, let's look at the ratios given in the table. A current ratio & quick ratio (Acid test ratio) greater than 1 are good indicators that a company has potential liquidity with resources to meet its short-term obligations.## Step 2:Observe the statements given - we need to find what the table does NOT interpret. ## Step 3:Go through each statement to ascertain if they are explained by the company’s liquidity position based on the given table or not.### Note: The current ratio measures a company's ability to pay its short-term obligations or liabilities with its short-term assets. The quick ratio is similar to the current ratio, but gives a more stringent analysis of a company's capability to meet its short-term liabilities.## Statement analysis:### "The ratios indicate that the company has sufficient liquid assets to meet shortterm obligations"The ratios mentioned in the given table indeed represent the company's ability to meet its obligations. This means that both the current ratio and quick ratio play an essential role in determining the liquidity of the company. In this scenario, owing to ratio values over 1 for corresponding years, it is evident that the company has sufficient liquid assets to meet the obligations.### "In 2022, for every £(1) of current liabilities, the company has £(1.6) liquid assets and £(1.3) current assets":Referring to the 2022 ratios in the given table, it states the current ratio is
and quick ratio is
. This implies that for every £(1) owed as current liability, the company owns £(1.6) liquid assets and £(1.3) current assets. So this representation is reconciled with data provided.### "There is no ideal current ratio that fits all businesses, different types of businesses in different sectors may require different current ratios":Yes, this is an accurate principle regarding financial statement analysis as it holds that there isn't a one-size-fits-all approach. Financial ratios such as liquidity ratios could vary broadly depending on the business nature and industry specifics.### "For a more stringent test of liquidity, inventory is excluded from the quick ratio calculation":This principle statement deals with the formulation of ratios indirectly rather than interpreting ratios as portrayed in table. Yet, its accuracy conforms to a universal occurrence in assessing the quick ratio, that eliminates inventory from the measure due its lesser liquidity nature. Hence, this statement is accurate.### "The business is in a better liquidity position in 2022 compared to the year before":Indeed, given the static analysis at snapshot toward ratios over two consecutive years simply notes that the company has a better liquidity position in 2022 than in 2021 based on the absolute ratio values designed for both the current and quick ratio.Through going over all the statements one by one, ∀ statements rightly interpret the given liquidity ratios of Dilva Ltd for 2022 & 2021.By mathematical elimination, an Incorrect statement doesn't exist.