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A company always maintains a positive cash balance
Which of the following statements relating to the company’s liquidity ratios is/are true?
(1) If the accounts payable payment period reduces, the acid test (quick) ratio will increase
(2) The acid test (quick) ratio will never be higher than the current ratio
(3) If the inventory turnover period increases, the current ratio will reduce3 only
1 and 2
1 only
2 and 3
1 is incorrect because payment payables period should increase for the current ratio to increase, 2 statement is confusing even though inventory is deducted it can be higher, in statement 3 shouldn’t the current ratio increase if the inventory turnover period is increasing?
1 is correct. If the payables period reduces then payables will reduce and therefore the current ratio will increase.
2 is correct. Current assets minus the inventory must be lower than current assets (or equal to the current assets if the inventory is zero). Therefore the acid test ratio can never be higher than the current ratio.
3 is not correct. If the inventory turnover increases then the inventory reduces, and therefore the current ratio reduces.
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