Question

In a paragraph answer:

Give an example of how 2 ratios are related and the impact changing one would have on another. For example, if you change the current ratio and decreased current liabilities to improve the ratio, what impact if any would that have on the debt to equity ratio?

Answer 1

Consider Current ratio and stock turnover ratio.

Stock turnover ratio is computed by dividing the cost of goods sold from the average stock. Alow stock turnover ratio indicates huge stock and a high stock turnover ratio indicates low stock.

in the case of the current ratio, it is obtained by dividing current assets from current liabilities. Any bid to improve the stock turnover ratio results in low stock no doubt. but a low stock results in a low current ratio.

Imaginary details :

Cost of goods sold	12,00,000
Closing stock	4,00,000
Accounts receivables	1,00,000
Cash	2,00,000
Closing stock	3,00,000
Accounts receivables	1,00,000

Scenario 1

(1)	(2)	(3)
Cost of goods sold	Closing stock	Stock turnover ratio
12,00,000	4,00,000	(1)/(2) =3
Current assets=7,00,000	Current liabilities =4,00,000	Current ratio
Closing stock	Closing stock	1)/(2) =1.75
Accounts receivables	Accounts receivables
Cash

If the company desires to improve the current ratio by reducing the stock turnover ratio, it leads to idle stock. if the company desires stock turnover ratio of 2

Scenario 1

(1)	(2)	(3)
Cost of goods sold	Closing stock	Stock turnover ratio
12,00,000	6,00,000	(1)/(2) =2
Current assets=9,00,000	Current liabilities =4,00,000	Current ratio
Closing stock	Closing stock	1)/(2) =2.25
Accounts receivables	Accounts receivables
Cash

Thus they are inter-related and desired change in one leads to undesirable change in the other ratio.