Financial Accounting: In an Economic Context

SUMMARY OF KEY POINTS

Current assets, working capital, current ratio, and quick ratio, and how these measures are used to assess the solvency position of a company.

Current assets are assets that can be converted into cash within one year or the company's operating cycle, whichever is longer. Working capital is equal to current assets less current liabilities, which are the liabilities expected to be required for payment with the assets listed as current. The current ratio is equal to current assets divided by current liabilities. The quick ratio is equal to cash plus marketable securities plus accounts receivable, divided by current liabilities.

These low-cost measures are useful in assessing a company's solvency position because they compare a measure of short-term cash inflows to a measure of short-term cash outflows. They are often used by banks and other lenders, and they appear in many loan agreements and debt covenants, enabling lenders to protect their investments by requiring that management maintain certain levels of liquidity.

“Window dressing” and the reporting of current assets, working capital, and the current ratio.

Window dressing refers to management's use of discretion in reporting accounting numbers to make the financial statements appear more attractive. Such ...