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The following information is available for Pind Co, a manufacturing company.
Operating profit 42,000
Interest charges (16,000)
Profit before tax 26,000
Taxation (5,460)
Net profit 20,540Pind Co has an operating profit margin of 15%. You are provided with an extract from its
Equity and reserves
Total equity and reserves 420,000
Non-current liabilities
Loan 150,000
5% Preference shares 40,000
Current liabilities
Payables 50,000Pind Co has a current ratio of 1.5 and a quick ratio of 0.9.
If cash in the bank is used to pay some of the payable, what will be the effect on the current and quick ratios?The correct answer was an increase for current ratio and a decrease for quick ratio.
Can you explain for me why? As no other explanation was given in the answer.For questions like this, best is to invent some figures and see what happens.
Suppose current liabilities are $100. The current assets are $150 and current assets excluding inventories are $90.
If the use (say) $20 cash to pay current liabilities, then current assets are $130 and current assets excluding inventories are $70. Current liabilities are $80.
So current ratio becomes 130/80 = 1.625 i.e. the ratio increases.
Quick ratio becomes 70/80 = 0.875 i.e. the ratio decreases.
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