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MeGarrett · Aug 26, 2010, 01:24 AM

A company has a current ratio of 0.5%. Which of the following actions would improve (increase) this ratio?

1. Use cash to pay off current liablities
2. Collect some of the current accounts receivable.
3. Use cash to pay off some long-term debt.
4. Purchase additional inventory on credit (accounts payable).
5. sell some of the existing inventory at cost.

After answer, please explain why.

pready · Aug 26, 2010, 04:24 PM

What do you think is the correct answer and why. We then can discuss your answer.

morgaine300 · Aug 26, 2010, 09:38 PM

I would suggest start with writing out your current ratio equation. Then for each item, think how that entry would be done, and therefore what accounts would be affected by it. And then further if, and how, that would affect the equation.

If nothing else, you should be able to eliminate some answers that way.

MeGarrett · Aug 27, 2010, 01:28 AM

A). Modern Medical Devices has a current ratio of 0.5. Which of the following actions would improve this ratio?
Answer): Purchase additional inventory on credit (i.e. accounts payable).
Example): For good results, use numbers. Current assets equal $50 and current ratio is 0.5. A $10.00 purchase of inventory on credit (accounts payable). The new current ratio would be $60/$110 = 0.55, making an increase over the past current ratio of 0.5.

MeGarrett · Aug 27, 2010, 01:34 AM

Originally Posted by pready

What do you think is the correct answer and why. We then can discuss your answer.

Answer): Purchase additional inventory on credit (i.e. accounts payable).
Example): For good results, use numbers. Current assets equal $50 and current ratio is 0.5. A $10.00 purchase of inventory on credit (accounts payable). The new current ratio would be $60/$110 = 0.55, making an increase over the past current ratio of 0.5.

morgaine300 · Aug 27, 2010, 03:05 AM

Good job. An important note here. Increasing both current asset and current liability by the same amount has a different effect depending on the ratio you started with. Increasing both by the same amount when it's over 1 makes it decrease. So, yes, you really need to make up some numbers to find out. (For most companies, being .5 would be considered a bad number. On the other hand, increasing it by buying inventory on credit, just for the purpose of increasing it, isn't necessarily the brightest idea and it makes quick ratio worse.)

Too much information? :-)