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In an attempt to increase sales revenue during the year, C Co offered extended credit terms
to its major customers. Whilst many major customers took advantage of the extended
credit period, C Co did not increase its volume of sales.
What impact did this have upon the current ratio?A There was no change to the current ratio
B It is not possible to determine the impact on the current ratio as there is insufficient
information available
C The current ratio increased
D The current ratio decreasedThe answer is C. But I do not inderstand why. As sales volume is not chaged it should not affect Current Asset. However, in the anwer they mentioned that receivbles are increased. Could you explain that please?
If customers are offered extended credit then this means they will take longer to pay. If they take longer to pay then the level of receivables will be higher. For example, if the take 2 months to pay then receivables at any time will be twice has high as if they were only taking 1 month to pay.
Ok. However there is relation between receivables and cash and both of them are Current Assets. While Receivables Increase Cash receipts will decrease or vice versa so no change in total CA which in turn no change in Current Ratio. So confusing .
The cash balance changes all the time for all sort of reasons – cash received from the receivables is only one of the reasons.
However if a business decides today to give 2 months credit instead of one months credit, then receivables will increase immediately, but the cash balance of today will not change.
if we have receivable of say 100,000 dollars today and we extend it for 2 months for payment but it should be paid today i mean that our cash should be increased by this amount. So it means our cash balance affected by this amount.
But todays cash balance will not change. So the immediate impact (which is what the question asks for) is simply for the receivables to increase and the current ratio to therefore increase.
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