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Hi Sir,
Below is the question from Kaplan exam kit.
436) 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 decreased
The answer given is C and the explanation given is
“If credit customers take advantage of extended credit periods, this will increase trade
receivables. If all other factors remain unchanged, there will be an increase in current assets
and, consequently, in the current ratio.But i think the answer is A since question mentioned “did not increase its volume of sales”, hence the trade receivables should remain the same and hence the current asset remains
Suppose sales are $1,000 per month.
If they give 1 months credit then receivables will be $1,000.
However if they give 2 months credit then they will always be being owed for 2 months sales and therefore the receivables will be $2,000.
I also think the answer is A. Because if the volume of sales remains with the major customers take advantage of the extended credit terms, then receivables will increase but at the same time cash will decrease since the amount of cash which the company could have received earlier before offering extended credit terms is now confined in receivables. So current ratio should not be affected when the total of numerator(Receivables and cash and inventory) remains same(upward receivables counteracts downward cash)?
Please tell me what I am misunderstanding here.
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