Question

Which of the following statements is CORRECT? a. If a firm sold some inventory on credit as opposed to cash, then there is no reason to think that either its current or quick ratio would change. b. If a firm has high current and quick ratios, then it must be managing its liquidity position well. c. If a firm sold some inventory on credit, then its current ratio would probably not change much, but its quick ratio would decline. d. The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its current assets. e. If a firm sold some inventory for cash and left the funds in its bank account, then its current ratio would probably not change much, but its quick ratio would decline.

Answer 1

a. If a firm sold some inventory on credit as opposed to cash, then there is no reason to think that either its current or quick ratio would change.

When a firm sells inventory on credit as opposed to cash then the current ratio would not change however its quick ratio would change because in quick ratio we will not take into consideration the inventory of the firm

Whereas in case of current ratio both the debtors increases and the inventory decreases, hence there would be no effect. However in case of quick ratio the debtors part increases in current assets but we will not take

inventory into account, hence there would be a change in quick ratio. This is partially correct.

b. If a firm has high current and quick ratios, then it must be managing its liquidity position well.

Yes, because if a firm has high current and quick ratios, it means that it has high proportion of current assets in relation to its current liabilities. In case of net current assets (also known as Working capital) being high, it means that

the firm has high liquidity to meet out its current liabilites

c. If a firm sold some inventory on credit, then its current ratio would probably not change much, but its quick ratio would decline.

If a firm sells some inventory on credit then its current ratio will not change as explained in part a of the question. Whereas the quick ratio would increase because the debtors (which is a current asset) increases and correspondingly

the quick ratio would also shoot up as inventory is excluded in quick ratio (rationally there will be changes in quick ratio). This is also partially correct (For the current ratio part)

d. The inventory turnover ratio and days sales outstanding (DSO) are two ratios that are used to assess how effectively a firm is managing its current assets.

The inventory turnover ratio measures how much of the sales the company has held as inventory and the DSO measures how much of the sales the company holds as debtors. These ratios partially help the firm in analysing

how it manages its current assets. Because other than debtors, cash is also a main component of current assets. The supreme ratio for find the effective usage of current assets would be current ratio and quick ratio. These ratio support

Current and quick ratio The statement is prima facie correct.

e. If a firm sold some inventory for cash and left the funds in its bank account, then its current ratio would probably not change much, but its quick ratio would decline.

If a firm sells some inventory for cash and deposits in bank account then its current ratio will not change as explained in "part a & c" of the question. Whereas the quick ratio would increase because cash and cash equivalents (which is a current asset) increases and correspondingly

the quick ratio would also shoot up as inventory is excluded in quick ratio (rationally there will be changes in quick ratio). This is also partially correct (The current ratio part of it is correct)