#6 Do the following events decrease, increase, or have no effect on a firm’s current ratio?...

#6 Do the following events decrease, increase, or have no effect on a firm’s current ratio?

Inventory is purchased with cash on hand.
Company XYZ takes out a 5-year loan, with the money being used to pay suppliers.
A customer pays a past due bill (the bill was not written off yet).
Company XYZ establishes a line of credit with Bank ABC, which will allow it to borrow money in the future.
The company sells a 10-year old machine, receiving cash from the sale.

Expert Solution

6.Current Ratio = Current Asset/Current Liability

Current Assets include Cash , Marketable Securities, Inventory etc

Current Liabilities include Short-term debts, Accounts Payable etc.

A: When inventory is purchased using cash, there is outflow of cash and inflow of invemtory. Hence, the overall change in current asset is zero. So, there is no change in the Current ratio as well.

B. A 5-year loan is a long term liability but payment to suppliers can incude accounts payable accounts which is categorized as a current liabilitiy. If current liablity decrease , the current ratio will increase

C:A past due bill paid means decrease in accounts payable account. Hence, the current ratio increases.

D: A line of credit is increase in current liability account. This will decrease the current ratio.

E. Sale of fixed asset lead to inflow of cash which is a current asset. So, the current ratio will increase.

jeff jeffy answered 2 years ago

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