Question

What effect would the following actions have on a firm's current ratio? Assume that net working capital is positive.

1) inventory is sold for a profit

a. not change                                      

b. decrease                                 

c. increase                

d. there is not enough information to answer this question                         

Answer 1

The current ratio is computed as follows:

= current assets / current liabilities

If the inventory is sold at a profit, it implies that the inventory's value or current asset went down. Further since the inventory is sold at a profit, it implies that the firm has received cash in excess of the inventory value which will result in net increase of the current assets.

So, since the transaction has resulted in to increase in the numerator without impacting the denominator, it implies that the current ratio will increase.

So, the correct answer is option c.