Reference no: EM13953468

Current Ratio Loan Provision

Assume that you are the controller of a small, growing sporting-goods company. The prospects for your firm in the future are quite good, but like many other firms, it has been experiencing some cash-flow difficulties because all available funds have been used to purchase inventory and to finance start-up costs associated with a new business. At the beginning of the current year, your local bank advanced a loan to your company. Included in the loan is the following provision:

The company is obligated to pay interest payments each month for the next five years. Prin- cipal is due and must be paid at the end of Year 5. The company is further obligated to maintain a current assets to current liabilities ratio of 2 to 1 as indicated on quarterly state- ments to be submitted to the bank. If the company fails to meet any loan provisions, all amounts of interest and principal are due immediately upon notification by the bank.

You, as controller, have just gathered the following information as of the end of the first month of the current quarter:

Current liabilities:

Accounts payable	$400,000
Taxes payable	100,000
Accrued expenses	50,000
Total current liabilities	$550,000

You are concerned about the loan provision that requires a 2 to 1 ratio of current assets to cur- rent liabilities.

Required

1. Indicate what actions could be taken during the next two months to meet the loan provision. Which of the available actions should be recommended?

2. Could management take short-term actions to make the company's liquidity appear to be better? What are the long-run implications of such actions?