Question

A firm wants to strengthen its financial position. Which of the following actions would increase its quick ratio?

a) Issue new common stock and use the proceeds to increase inventories.

b) Use some of its cash to purchase additional inventories.

c ) Speed up the collection of receivables and use the cash generated to increase inventories.

d) Offer price reductions along with generous credit terms that would (1) enable the firm to sell some of its excess inventory and (2) lead to an increase in accounts receivable.

e) Issue new common stock and use the proceeds to acquire additional fixed asset

Answer 1

Quick ratio is a measure of liquidity calculated dividing current assets minus inventory and prepaid expenses by current liabilities.

The term quick assets refers to current assets which can be converted into cash immediately or at a short notice without diminution of value. Included in this category of current assets are (i) cash & bank balances (ii) short-term marketable securities and (iii) debtors/accouts receivables. thus the current assets which are excluded are: Prepaid expenses and inventory. The exlusion of inventory is based on the reasoning that it is not readily convertible into cash. Prepaid expenses by their very nature are not available to pay off current debts. They such reduce the amount of cash requiredin one period because of payment in prior period.

From the given option (a), (b), (c) are related to increase in inventory and as per above definition it reduces (option b&c)/no effect(option a) on quick assets so they should not be the right answer.

in option (e) no effect on current assets and current liabilities as cash from issue of shares will be used to acquired fixed assets.

only option (d) seems to be the right answer as it reduces the inventories and increase the accounts receivable which results higher quick assets and higher quick ratio.

so option (d) should be the right answer.

Please check with your answer and let me know.