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CS Executive · Corporate Accounting and Financial Management · Financial Statement Analysis

A firm with a current ratio of 2:1 (current assets ₹4,00,000) uses ₹50,000 of cash to pay a trade creditor. What is the effect on the current ratio?

The current ratio rises to about 2.33:1. Current liabilities were ₹2,00,000; paying ₹50,000 reduces both current assets and liabilities, giving 3,50,000/1,50,000. When the ratio exceeds one, equal reductions in both improve it. Reducing only assets would wrongly show a fall.

  1. AIt rises to about 2.33:1Correct
  2. BIt falls to about 1.75:1
  3. CIt remains 2:1
  4. DIt rises to 2.5:1

Explanation

Current liabilities = 2,00,000. After payment, CA = 3,50,000 and CL = 1,50,000, giving 2.33:1. The ratio rises because a ratio above 1 improves when equal amounts reduce both numerator and denominator. Option 1.75 wrongly reduces only current assets.

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