Two companies wish to obtain a loan. The first is Potz and Pans, with current assets totaling $45,000, including inventory valued at $30,000 and $9,000 in current liabilities. The second is WannaBees, with current assets totaling $150,000, including inventory valued at $125,000 and $85,000 in current liabilities. The current ratio for Potz and Pans is 5.00:1, while the current ratio for WannaBees is 1.76:1; given these numbers, Potz and Pans is more likely to obtain a loan because their ratio is better. They have less debt when compared to their available assets, making them a better risk for the bank itself.
The quick acid test ratio for Potz and Pans is 1.67:1, while the quick acid test ratio for WannaBees is 0.29:1, meaning once more that Potz and Pans is more likely to get the loan, given that even when taking inventory into account, they are still the better risk for the bank itself. If I were to give either of these companies a bank loan, it would be Potz and Pans given the decreased amount of debt held by the company when compared to the current assets. It is clear that of the two Potz and Pans has either been incredibly lucky, managed their company well, or both, while WannaBees has not done as well. Given that this concerns the lending out of money, I would be more likely to loan money to the company that has shown better debt management skills, however I would need more information in order to be able to make my determination, including information on what their future plans are, how old the businesses are, and what their market projections are. No matter how good a potential risk may seem, there could be other factors that would make the lending of money to be less profitable for the bank itself, and the bank that is providing the loan must always look out for its own interests first, which means doing far more research than simply obtaining two ratios and making a determination from there.
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