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ACCA Applied Skills · Financial Management · The nature, elements and importance of working capital

A company has current assets of $600,000 (inventory $300,000) and current liabilities of $400,000. Management uses $100,000 of cash to repay a trade payable. What is the effect on the current ratio and the quick ratio? Assume cash is part of the non-inventory current assets.

Repaying a payable with cash lifts the current ratio from 1.50 to 1.67 but lowers the quick ratio from 0.75 to 0.67, because the ratio is below 1 for the quick measure and removing equal amounts from numerator and denominator reduces it.

  1. ACurrent ratio rises from 1.50 to 1.67; quick ratio rises from 0.75 to 0.67
  2. BCurrent ratio rises from 1.50 to 1.67; quick ratio falls from 0.75 to 0.67Correct
  3. CCurrent ratio falls from 1.50 to 1.25; quick ratio falls from 0.75 to 0.50
  4. DBoth ratios are unchanged

Explanation

Before: current ratio 600/400 = 1.50; quick ratio (600-300)/400 = 0.75. After: current assets 500, liabilities 300. Current ratio 500/300 = 1.67; quick ratio 200/300 = 0.67. So the current ratio rises while the quick ratio falls. Option A wrongly shows the quick ratio rising.

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