Santos has a high level of current liabilities compared to its cash on

QUESTION

Santos has a high level of current liabilities compared to its cash on hand. One company executive predicts that this means that Santos will not have a good acid-test ratio. Which of the following points out a flaw in his argument?

A) Current liabilities are not relevant to the acid-test ratio.
B) The company may have more cash in the next fiscal year.
C) Marketable securities and receivables also need to be accounted for.
D) A current ratio is a better measure of the company’s level of liabilities.
E) Santos may be able to take out short-term loans to improve its acid-test ratio.

ANSWER

Answer: C
Explanation: C) When calculating the acid-test ratio, marketable securities and receivables must be added to cash, with the sum of those three measures being compared to current liabilities. Choice A: Current liabilities are relevant to the acid-test ratio, though not sufficient. Choice B: More cash available in the following year is not relevant to the acid-test ratio for the current year. Choice D: The relative value of the current ratio to the acid-test ratio is beside the point. Choice E: Short-term loans would increase the current liabilities figure and thus worsen Santos’s acid-test ratio. In any case, the executive’s prediction relates to the company’s present situation.