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Dear Mike,
Could you kindly help?
The finance director of Sandbag knows that the acid test ratio is below 1. He is planning two two changes
1. Offering a 2% early settlement discount to credit customers
2. Delaying payment to all trade payable by one extra monthWhat effect would each of these proposals have on the acid test ratio?
1: Decrease ratio /2. Increase ratio.
It is clear the effect of the proposal 1, but it still unclear the effect of proposal 2
It is true that if I post-pone the payment of supplier we delay the decrease of cash , but at the same time we delay the decrease of liability therefore the acid ratio should not increase.
Do I miss anything or Am I confused?
Could you please clarify to me?
thanks a lot
Gabriella
Yes – it’s the proportions that are important
Try these figures
Current assets (excluding inventory) $50,000
Current liabilities $60,000Acid test .833 : 1
Say we have just paid payables an amount of $15,000
If we had delayed that payment for 1 month, cash would increase, but so too would current liabilities increase by the same amount
So acid test now becomes:
$65,000 : $75,000
Is the same as .866 : 1
So the acid test has increased / improved
Always be prepared to put ‘pretend’ figures into a working so you can better see the effect
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