Question

In: Finance

A decrease in which one of the following accounts increases a firm's current ratio as well...

A decrease in which one of the following accounts increases a firm's current ratio as well as its quick ratio?

A. Accounts payable

B. Cash

C. Accounts receivable

D. Inventory

E. Fixed assets

Expert Solution

Current ratio = current assets / current liabilities

Current ratio can be increased either by increase in current assets or by decrease in current liabilities.

Quick ratio = Liquid assets / current liabilities

Quick ratio can be increased either by increase in liquid assets or by decrease in current liabilities.

Hence answer is Option A- Accounts payable [being a current liability decrease in accounts payable increase current ratio as well as quick ratio]

Suppose Cash = 10000, debtors = 20000, inventory = 40000 and account payable = 10000

Current Ratio = Current assets / current liabilities = 10000+20000+40000/10000 = 7 times

Quick ratio = Liquid assets / current liabilities = 10000+20000/10000 = 3 times

Suppose accounts payable reduce by 5000 then

Current Ratio = Current assets / current liabilities = 10000+20000+40000/5000 = 14 times

Quick ratio = Liquid assets / current liabilities = 10000+20000/5000 = 6 times

So reduction in accounts payable resulted in increase in current ratio from 7 to 14 and increase in quick ratio from 3 to 6 times.

jeff jeffy answered 2 years ago

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