A company has a liquidity ratio equal to 0.5. The directors believe that the company has to reduce its bank overdraft and have agreed to alter the company’s credit terms to customers from two months to one month.
What would be the effect on the company’s liquidity ratio if this change were to be achieved?
answer: The liquidity ratio would decrease.
The liquidity ratio would decrease. The reduction in receivables and in the overdraft mean that the numerator and denominator of the liquidity ratio would both reduce by the same amount. Therefore, the ratio would decrease.
sir why would the Trade receivables reduce? and secondly why would they reduce by the same amount as Overdraft?
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liquidity ratio
5y ago#1If customers pay sooner, then receivables will only be 1 months sales rather than 2 months sales.
The month the policy is changed we receive 1 months extra cash and this can be used to reduce the overdraft.
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