The Allen Marble Company has a target current ratio of 2.0 but has experienced some difficulties financing its expanding sales in the past few months. At present the firm has current assets of $2.5 million and a current ratio of 2.5. If Allen expands its receivables and inventories using its short-term line of credit, how much additional short-term funding can it borrow before its current ratio standard is reached?

The additional short-term funding that can be borrowed is 500,000

Explanation:

First the amount of current liabilities must be known:

Current Ratio = Current Asset / Current Liabilities

2.5 = 2,500,000 / X

X = 2,500,000 / 2.5

X = 1,000,000

To know how much to expand receivables and inventories in the formula of the current ratio, to the amount of current assets and current liabilities must add an amount such that the result is 2.0.

(2,500,000 + x) / (1,000,000 + x) = 2.0

(2,500,000 + x) = 2.0 * (1,000,000 + x)

2,500,000 + x = (2.0 * 1,000,000) + (2.0 x)

2,500,000 + x = 2,000,000 + 2.0 x

2,500,000 - 2,000,000 = 2.0 x - x

500,000 = x

So the maximum that should be expand inventory and receivables is $500,000.