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Outline two reasons why a business would calculate the Working Capital Ratio - Leaving Cert Business - Question 9 - 2001
Question 9
Outline two reasons why a business would calculate the Working Capital Ratio. (A) (B)
Worked Solution & Example Answer:Outline two reasons why a business would calculate the Working Capital Ratio - Leaving Cert Business - Question 9 - 2001
Step 1
Reason (A): To Assess Liquidity
Answer
A business calculates the Working Capital Ratio to assess its liquidity position. By analyzing current assets against current liabilities, the ratio helps determine whether the company has enough short-term assets to cover its short-term obligations. A ratio of less than 1 indicates potential liquidity issues, prompting management to take necessary actions to improve cash flow.
Step 2
Reason (B): To Optimize Operational Efficiency
Answer
Additionally, the Working Capital Ratio aids businesses in optimizing their operational efficiency. A favorable ratio suggests that the company is effectively managing its assets and liabilities, thus allowing it to invest in growth opportunities or reduce unnecessary costs. Conversely, an unfavorable ratio can signal the need for better inventory management or tighter credit control.