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.

One more question...

3. a short-term bank loan is repaid
This one I know increases CR, but again, I don't understand why.

Quote:

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Originally Posted by student0812

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.

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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