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A firm with current assets of $40 million and current liabilities of $20 million buys $5 million of inventory on credit which increases its inventory level to $10 million.
What will the effect be on its current ratio and quick ratio?
Current ratio. quick ratio
A) increase by 25%. Unchanged
B) reduce by 10%. Unchanged
C) increase by 25%. Reduce by 20%
D) reduce by 10%. Reduce by 20%Answer D
Sir I’m really puzzled out by this question, normally i can solve these current and quick ratio without any trouble, but here I’m rlly confused,
Method i used
As it says increase in inventory level means our asset increased and on credit means our liability increases So first finding current ratio
40/20 = 2 without the new inventory
With new inventory 40+10/20+5 = 2 same no change in current ratio, though there is no option available in the given question options 🙁
For quick ratio
We exclude inventories, but our liabilities will increase
40/20 =2 without the new inventory
40/20+5= 1.6
1.6-2/2= 0.2 aka 20 % reduce in quick ratio this one is correct, please sir could you explain me this question
there is currently 5m of inventory.
At the moment the current ratio = 40/20 =2, and the quick ratio = 35/20 = 1.75
After buying 5M inventory on credit, the current ratio = 45/25 = 1.8, and the quick ratio is 35/25 = 1.4
The current ratio reduces by 0.2/2 = 10%. The quick ratio reduces by 0.35/1.75 = 20%
Sir what I don’t understand is when you’re calculating current ratio, it’s 40/20 but for quick instead of current assets to be 40 you reduce it to 35 why? I know it says 5m inventory bought, but wouldn’t that be calculated in the new one quick ratio, not the current one? It doesn’t says those 40 assets include 5m inventory? Also sir what about those inventory levels increases by 10m i didn’t get it, i mean we wouldn’t include it in current assets? Since our inventory level is increasing? Sorry sir im really confused here
The question says that they buy inventory for $5M and that it increases the inventory to $10M.
That must mean that they currently have inventory of $5 (so the extra $5 will increase it to $10).
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