ACCA Applied Knowledge · Financial Accounting · Ratios
Kappa Co has current assets of $540,000, of which inventory is $240,000, and current liabilities of $300,000. Last year the current ratio was 1.5 and the quick ratio was 1.1. Which is the most appropriate interpretation of this year's position?
The current ratio is 1.8 and the quick ratio is 1.0. The current ratio improved from 1.5 but the quick ratio fell from 1.1, so the improvement comes from higher inventory rather than from more liquid assets such as cash and receivables.
- ACurrent ratio 1.8 and quick ratio 1.0; liquidity appears to depend more on inventory than last yearCorrect
- BCurrent ratio 1.8 and quick ratio 1.8; liquidity has improved on both measures
- CCurrent ratio 1.0 and quick ratio 0.8; liquidity has worsened sharply
- DCurrent ratio 1.8 and quick ratio 0.6; liquidity is poor because of inventory
Explanation
Current ratio = 540/300 = 1.8 (up from 1.5). Quick ratio = (540-240)/300 = 1.0 (down from 1.1). The current ratio improved while the quick ratio fell, so inventory is making up more of the liquidity. The option with a quick ratio of 0.6 wrongly deducts inventory twice.
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