View Full Version : What happens to a firm's current ratio if...
student0812
Sep 23, 2010, 10:54 PM
1. Inventory is purchased on credit.
2. Inventory is purchased using a short-term bank loan
3. a short-term bank loan is repaid
I know 1 and 2 both decrease the current ratio, but I don't understand why. Won't they both increase by the same amount? 3 I know increases CR, but again, I don't understand why.
student0812
Sep 23, 2010, 10:56 PM
One more question...
3. a short-term bank loan is repaid
This one I know increases CR, but again, I don't understand why.
rehmanvohra
Sep 24, 2010, 06:10 AM
1. Inventory is purchased on credit.
2. Inventory is purchased using a short-term bank loan
3. a short-term bank loan is repaid
I know 1 and 2 both decrease the current ratio, but I don't understand why. Won't they both increase by the same amount? 3 i know increases CR, but again, I don't understand why.
You will best understand if you take example. Assume Current assets are 2.000 and current liabilities are 1,000. The current ratio is 2:1. Now for the assumptions given.
1. Inventory of 1,000 purchased on credit. This will increase current assets to 3,000 and current liabilities to 2,000. The CR has fallen to 1.5:1.
2. Has the same effect
3. Repayment of 500 of the short term loan will reduce the current assets to 1,500 and current liabilities to 500. Now the CR increases to 3:1