Week 2 DQ2 Financial Statement Analysis ACC206 Principles of Accounting II AU Financial Statement Analysis Discuss what high current ratios indicate and why are businesses with extremely high current ratios example 25 0 at risk Explain what a high accounts receivable turnover indicates to a business Discuss what high current ratios indicate and why are businesses with extremely high current ratios example 25 0 at risk Current ratio is equal to current assets divided by current liabilities It is an indication of company s ability to pay its short term liability with its short term assets A current ratio of 2 or more is generally desirable as it would indicate that the company is in good financial condition If it s bellow 1 it could mean that company would not be able to pay off its short term liabilities at that time as it does not have enough cash on hand it s not liquid There are many other important indicators and bad current ratio alone does not mean that company will go bankrupt A current ratio that is too high is not desirable as well It could mean that the company is not using assets to grow the business which could hurt it in the long run Explain what a high accounts receivable turnover indicates to a business By maintaining accounts receivable firms are indirectly extending interest free loans to their clients A high ratio implies either that a company operates on a cash basis or that its extension of credit and collection of accounts receivable is efficient To put it in simple terms the higher the turnover ratio the faster a business is collecting its receivables and the more cash the company generally has on hand Generally this means it s good However an usually high turnover compared to your competitors could mean that your credit terms are tighter than your competitors and you run the risk of losing customers to them A low ratio implies the company should re assess its credit policies in order to ensure the timely collection of imparted credit that is not earning interest for the firm