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    student0812's Avatar
    student0812 Posts: 5, Reputation: 1
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    #1

    Sep 23, 2010, 10:54 PM
    What happens to a firm's current ratio if...
    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's Avatar
    student0812 Posts: 5, Reputation: 1
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    #2

    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's Avatar
    rehmanvohra Posts: 739, Reputation: 27
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    #3

    Sep 24, 2010, 06:10 AM
    Quote Originally Posted by student0812 View Post
    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
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