How would the following actions affect a firm's current ratio?
1. Inventory is sold.
2. The firm takes out a bank loan to pay its suppliers.
3. A customer pays its overdue bills.
4. The firm uses cash to purchase additional inventories


Thank you

Quote:

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Originally Posted by millieJP

How would the following actions affect a firm's current ratio?
1. Inventory is sold.
2. The firm takes out a bank loan to pay its suppliers.
3. A customer pays its overdue bills.
4. The firm uses cash to purchase additional inventories


Thank you

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Current Ration is Current Assets(Short Term Assets) divided by Current Liabilities(short term liabilities). It is used to determine if a company can pays its short term obligations with its current assets. The current ratio is another test of a company's financial strength. It calculates how many dollars in assets are likely to be converted to cash within one year in order to pay debts that come due during the same year.

1. Inventory sold would produce Sales, and that's not an Asset its Revenue, but it would decrease assets and increase cash. So it wouldn't have any affect on the current ratio because it evens out.
2. A bank loan is a long term liability and therefore wouldn't be calculated into the current ratio.
3. If a customer pays its bills then Account Recievable(current ratio variable) would go down and and cash(current ration variable) would go up, but it gets equaled out so it wouldn't effect the ratio.
4. Again assets would go for the purchase of Inventories, but it would go down because cash was used, so there would be no effect on the ratio because they are both short term assets.

I agree with mh34.

However, I wish to clariffy his explanation to point 2.

The bank loan will increase your cash (current ratio), but you are using that money to pay off suppliers (current ratio). So it balances itself out.