Can you think of a situation where the current ratio is very misleading as an indicator...

Can you think of a situation where the current ratio is very misleading as an indicator of short term, debt paying ability? Does the acid test ratio offer a remedy to the situation you have described?

Expert Solution

Yes, it is true that current ratio is very misleading as an indicator of short term, debt paying ability because current ratio is based on current assets and current liabilities. And we know that all current assets are not real liquid in nature such as; inventory and prepaid expenses. So when inventory and prepaid expenses are not in real form of liquid cash then it can not depict true picture of short term, debt paying ability because short-term debt paying capacity can be measured more accurately on the basis of real liquid assets which can be measured with the help of acid test ratio.

Thus, we can say that acid test ratio offer a remedy to the situation because acid test ratio is calculated on the basis of liquid assets and current liabilities and we know that liquid assets include only those assets which can be easily converted into cash. That is why such liquid assets will help in measuring actual & true short-term debt paying capacity.

Hence we can say at last that current ratio is very misleading as an indicator of short term, debt paying ability whereas acid test ratio offer a remedy to the situation.

ekkarill92 answered 1 year ago

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