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    jamesk486's Avatar
    jamesk486 Posts: 18, Reputation: 1
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    #1

    Jul 21, 2010, 06:48 AM
    Effect on sale from gross margin
    A company makes a cash sale with a positive gross margin. Which one of the following statements describes the effect of the sale on the company?
    A. Current ratio increases
    B. Current ratio decreases
    C. No change to Juan Foods’ current ratio
    D. Insufficient information to judge effect on current ratio
    ArcSine's Avatar
    ArcSine Posts: 969, Reputation: 106
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    #2

    Jul 21, 2010, 09:39 AM
    Ya got to show some effort, James... you've read the forum's homework-help guidelines.
    jamesk486's Avatar
    jamesk486 Posts: 18, Reputation: 1
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    #3

    Jul 21, 2010, 03:59 PM

    Well I thought that the answer was b.. since cash has increased and current ratio is current asset / current liabilities, the total ratio would be smaller.
    That's my opinion but not sure if it is right.
    Just Looking's Avatar
    Just Looking Posts: 1,610, Reputation: 480
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    #4

    Jul 21, 2010, 10:53 PM

    Cash increases. Cash is a current asset. Do you want to try again? :)
    ArcSine's Avatar
    ArcSine Posts: 969, Reputation: 106
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    #5

    Jul 22, 2010, 04:47 AM
    Don't overlook the words "...with a positive gross margin", which is necessary tidbit for answering correctly.

    In a sale, you've just swapped one asset (inventory) for another (cash). If it was an equal trade, then total current assets would be left unaffected (and so too, then, the current ratio).

    But a sale that generates a profit ("positive gross margin") implies that you've received an amount of cash from Customer that's greater than the dollar amount of inventory that went out the door under Customer's arm. Cash up; Inventory down; but overall, Current Assets have increased since the former exceeds the latter.

    In the Current Ratio, the denominator (current liabilities) are unaffected by the sale; whereas we've just seen that the numerator has increased.
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