- A company uses $100,000 of cash to pay for a one-year insurance policy on January 1. Immediately before this transaction, its current ratio was 3.0:1 and its quick ratio was 2.0:1. What are the approximate current and quick ratios immediately after this transaction?
Answer: Current Ratio = 3.0, Quick Ratio = 1.5
The transaction involves exchanging one current asset (cash) for another current asset (prepaid insurance). Therefore, total current assets remain unchanged, and since current liabilities are also unchanged, the current ratio remains 3.0. However, cash is a quick asset, while prepaid insurance is not. This means that quick assets decrease by $100,000. Since quick assets decrease while current liabilities stay the same, the quick ratio must decrease. Although we can't find the exact new value without knowing the initial dollar amounts, we know it must be less than 2.0. Choice B is the only one that reflects an unchanged current ratio and a decreased quick ratio.
- A company's current ratio is 1.2. The company uses $100,000 cash to acquire a building. How does this transaction affect the current ratio?
Answer: The current ratio will decrease.
The transaction involves decreasing a current asset (cash) by $100,000 and increasing a non-current asset (building) by $100,000. Current liabilities are unaffected. Since the numerator of the current ratio (Current Assets) decreases while the denominator (Current Liabilities) remains the same, the ratio must decrease. The initial value of the ratio is irrelevant in this specific case.
- A company reports a current ratio of 2.5 and a quick ratio of 1.8. If current liabilities total $240,000, and the company's inventory represents 60% of total inventory and prepaid expenses combined, what is the book value of the company's inventory?
Answer: $100,800
Current assets = 2.5 × $240,000 = $600,000. Quick assets = 1.8 × $240,000 = $432,000. Inventory + Prepaid expenses = $600,000 - $432,000 = $168,000. Since inventory represents 60% of (inventory + prepaid expenses): Inventory = 0.60 × $168,000 = $100,800.
- A company's management takes action to 'window dress' its financial statements at year-end. The company has a current ratio greater than 1.0. Which of the following actions would artificially inflate the current ratio reported at year-end?
Answer: Aggressively paying down accounts payable using cash right before year-end.
When the current ratio is greater than 1.0, decreasing current assets and current liabilities by the same amount will increase the ratio. For example, if CA=$200k and CL=$100k (Ratio=2.0), paying $50k of A/P with cash results in CA=$150k and CL=$50k (Ratio=3.0). This makes liquidity appear stronger. Delaying payments (C) increases both cash and A/P (relative to what they would have been), which would decrease the ratio. Purchasing inventory on credit (D) also decreases the ratio when it starts above 1.0.
- A company's current ratio has remained stable at approximately 2.5:1 for the past three years. However, its quick ratio has declined steadily from 1.8:1 to 1.1:1 over the same period. What is the most likely cause for this trend?
Answer: The company has accumulated a significant amount of obsolete or slow-moving inventory.
The divergence between the current ratio and the quick ratio indicates a change in the composition of current assets. Since the current ratio is stable, total current assets relative to total current liabilities is constant. The declining quick ratio means that quick assets (cash, marketable securities, A/R) are decreasing as a percentage of current liabilities. This implies that the non-quick current assets, primarily inventory, must be increasing as a proportion of total current assets. A buildup of slow-moving or obsolete inventory is the most common reason for this pattern.
- A firm has a quick ratio of 1.2 and current liabilities of $250,000. The company then collects a $50,000 account receivable. What is the firm's quick ratio immediately after this transaction?
Answer: 1.20
The quick ratio is calculated as (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities. When a company collects an account receivable, cash increases by $50,000 and accounts receivable decreases by $50,000. Both of these are quick assets. Therefore, the total value of quick assets remains unchanged. Since current liabilities are also unaffected by this transaction, the quick ratio does not change from its initial value of 1.20.
- A company writes off $40,000 of obsolete inventory. Immediately before the write-off, the company's current assets were $500,000 (including the obsolete inventory) and its quick assets were $300,000. Current liabilities were $200,000. What is the company's quick ratio after the inventory write-off?
Answer: 1.50
An inventory write-off reduces the value of inventory and total current assets. However, inventory is not included in the calculation of quick assets. Therefore, the value of quick assets remains unchanged at $300,000. The transaction also has no effect on current liabilities, which remain at $200,000. The new quick ratio is calculated as Quick Assets / Current Liabilities = $300,000 / $200,000 = 1.50. The current ratio would decrease, but the quick ratio is unaffected.
- A company is subject to a loan covenant that requires it to maintain a quick ratio of at least 1.0. The company currently has quick assets of $350,000 and current liabilities of $320,000. The company needs to purchase $60,000 of inventory. What is the maximum amount of this purchase that can be financed with short-term credit (accounts payable) without violating the covenant?
Answer: $30,000
Let 'x' be the amount financed on account. This transaction increases current liabilities by x but does not affect quick assets. The covenant requires (Quick Assets) / (Current Liabilities + x) ≥ 1.0. Plugging in the numbers: $350,000 / ($320,000 + x) ≥ 1.0. This simplifies to $350,000 ≥ $320,000 + x. Solving for x gives x ≤ $30,000. Therefore, the maximum amount that can be financed through accounts payable is $30,000. The remaining $30,000 of the purchase must be paid in cash to avoid violating the covenant.
- Company X and Company Y operate in the same industry and have identical current ratios of 2.2:1. However, Company X has a quick ratio of 1.8:1, while Company Y has a quick ratio of 1.0:1. Which of the following statements is the most likely interpretation of this data?
Answer: Company Y holds a larger proportion of its current assets in inventory than Company X.
The primary difference between the current ratio and the quick ratio is the exclusion of inventory (and prepaid expenses). A larger gap between the two ratios indicates that inventory constitutes a significant portion of current assets. Since Company Y has a much larger drop from its current ratio (2.2) to its quick ratio (1.0) than Company X does (2.2 to 1.8), it implies that Company Y's current assets are more heavily weighted towards inventory.
- A company has a quick ratio of 1.5, accounts receivable of $120,000, and cash of $80,000. It has no marketable securities. Its current ratio is 2.2. What is the value of the company's inventory?
Answer: $93,333
This is a multi-step problem. Step 1: Calculate Quick Assets (QA) = Cash + A/R = $80,000 + $120,000 = $200,000. Step 2: Use the quick ratio to find Current Liabilities (CL). QA / CL = 1.5 => $200,000 / CL = 1.5 => CL = $200,000 / 1.5 ≈ $133,333. Step 3: Use the current ratio to find Current Assets (CA). CA / CL = 2.2 => CA / $133,333 = 2.2 => CA = 2.2 * $133,333 ≈ $293,333. Step 4: Calculate Inventory. Inventory = Current Assets - Quick Assets = $293,333 - $200,000 = $93,333.
- Two companies in the same industry have the following liquidity metrics: Company M has a current ratio of 1.4 and quick ratio of 1.1; Company N has a current ratio of 3.2 and quick ratio of 0.9. An analyst should be most concerned about which aspect of these companies' liquidity management?
Answer: Company N's low quick ratio relative to its current ratio suggests over-investment in slow-moving inventory
Company N's large gap between current ratio (3.2) and quick ratio (0.9) indicates that most current assets are tied up in inventory and prepaid expenses, suggesting poor inventory management or slow-moving stock. Company M's ratios, while lower, are more balanced and indicate reasonable liquidity. The concern is Company N's potential inventory problems, not Company M's working capital adequacy.
- If Delta Services proceeds with the factoring arrangement, how will this transaction affect the company's current ratio and quick ratio?
Answer: Current ratio will decrease slightly, quick ratio will decrease slightly due to the factoring cost
The factoring converts $50,000 receivables to $46,000 cash ($50,000 - 8% fee), reducing current assets by $4,000. Current ratio changes from $300,000/$200,000 = 1.50 to $296,000/$200,000 = 1.48. Quick assets decrease from $180,000 to $176,000, so quick ratio changes from 0.90 to 0.88. Both ratios decrease slightly due to the factoring cost, not because cash replaced receivables.
- A company has a current ratio of 2.0:1, with current assets of $500,000 and current liabilities of $250,000. The company then declares a cash dividend of $50,000. What is the company's current ratio immediately after the declaration, but before the payment?
Answer: 1.67:1
The declaration of a cash dividend creates a current liability called 'Dividends Payable'. It does not affect current assets until the dividend is actually paid. Therefore, after the declaration, current assets remain at $500,000, but current liabilities increase by the dividend amount to $250,000 + $50,000 = $300,000. The new current ratio is $500,000 / $300,000 ≈ 1.67:1.
- A company has working capital (Current Assets - Current Liabilities) of $60,000. Its current ratio is 2.5. What are the company's current liabilities?
Answer: $40,000
This problem requires solving a system of two equations. Let CA be current assets and CL be current liabilities. Equation 1: CA - CL = $60,000. Equation 2: CA / CL = 2.5. From Equation 2, we get CA = 2.5 CL. Substitute this into Equation 1: (2.5 CL) - CL = $60,000. This simplifies to 1.5 * CL = $60,000. Solving for CL: CL = $60,000 / 1.5 = $40,000.
- A company's quick ratio is 0.9. Its inventory is $200,000 and its prepaid expenses are $50,000. Its current liabilities are $500,000. What is the company's current ratio?
Answer: 1.40
This problem requires working backwards from the quick ratio to find the current ratio. Step 1: Find Quick Assets (QA). QA = Quick Ratio × Current Liabilities = 0.9 × $500,000 = $450,000. Step 2: Find Current Assets (CA). CA = Quick Assets + Inventory + Prepaid Expenses. CA = $450,000 + $200,000 + $50,000 = $700,000. Step 3: Calculate the Current Ratio. Current Ratio = CA / CL = $700,000 / $500,000 = 1.40.
- A company has working capital of $90,000, a current ratio of 1.75:1, and no inventory or prepaid expenses. The company uses cash to purchase $30,000 in short-term marketable securities. What is the company's quick ratio after this transaction?
Answer: 1.75:1
Purchasing marketable securities with cash exchanges one quick asset (cash) for another quick asset (marketable securities). The total amount of quick assets remains unchanged at $210,000, and current liabilities remain at $120,000. Since the company has no inventory or prepaid expenses, all current assets are quick assets, so the quick ratio equals the current ratio of 1.75:1.
- A company wants to improve its current ratio of 1.6:1 to a target of 2.0:1 before its fiscal year-end. Current assets are $400,000. The company plans to use cash to pay down accounts payable. How much cash must the company use to pay down its accounts payable to achieve the target ratio?
Answer: $100,000
This requires setting up an equation. First, calculate current liabilities: CL = CA / Ratio = $400,000 / 1.6 = $250,000. Let 'x' be the amount of cash used to pay down accounts payable. The new current assets will be ($400,000 - x) and new current liabilities will be ($250,000 - x). The target ratio is 2.0. So, ($400,000 - x) / ($250,000 - x) = 2.0. Solving for x: $400,000 - x = 2 * ($250,000 - x) => $400,000 - x = $500,000 - 2x => x = $100,000.
- If Phoenix Manufacturing needs to maintain a minimum quick ratio of 1.0 to comply with a loan covenant, what is the maximum additional short-term borrowing the company can undertake without violating this requirement?
Answer: $45,000
Quick assets = Cash $80,000 + Short-term investments $40,000 + Accounts receivable $150,000 = $270,000. Current liabilities = $120,000 + $30,000 + $50,000 + $25,000 = $225,000. With additional borrowing of X, the quick ratio must be ≥ 1.0: $270,000 ÷ ($225,000 + X) ≥ 1.0. Solving: $270,000 ≥ $225,000 + X, so X ≤ $45,000. The maximum additional borrowing is $45,000.
- After the inventory purchase transaction, what will be the approximate change in Apex Corporation's liquidity ratios?
Answer: Current ratio will decrease to 1.44, quick ratio will decrease to 0.82
Before transaction: Current ratio = $450,000/$300,000 = 1.50; Quick ratio = $300,000/$300,000 = 1.00. After transaction: Current assets = $450,000 + $60,000 - $20,000 = $490,000; Current liabilities = $300,000 + $40,000 = $340,000; Quick assets = $300,000 - $20,000 = $280,000. New ratios: Current ratio = $490,000/$340,000 = 1.44; Quick ratio = $280,000/$340,000 = 0.82.
- An analyst is comparing two companies with identical current ratios of 2.0. Company X has a quick ratio of 1.5, while Company Y has a quick ratio of 0.8. What can be concluded about these companies' liquidity profiles?
Answer: Company X maintains lower inventory levels relative to current liabilities compared to Company Y
When you encounter liquidity ratio questions, focus on what each ratio measures and how they relate to each other. The current ratio includes all current assets, while the quick ratio excludes inventory and other less liquid assets.
Since both companies have identical current ratios of 2.0, their total current assets equal exactly twice their current liabilities. However, their quick ratios tell a different story about asset composition. Company X's quick ratio of 1.5 means its quick assets (cash, marketable securities, and receivables) are 1.5 times its current liabilities. Company Y's quick ratio of 0.8 means its quick assets are only 0.8 times current liabilities.
The difference between current ratio (2.0) and quick ratio reveals inventory levels. For Company X: 2.0−1.5=0.5, meaning inventory represents 0.5 times current liabilities. For Company Y: 2.0−0.8=1.2, meaning inventory is 1.2 times current liabilities. Therefore, Company X maintains significantly lower inventory levels relative to current liabilities, making answer D correct.
Answer A is wrong because having adequate liquid assets doesn't necessarily indicate poor management. Answer B incorrectly frames higher inventory as "conservative" when it actually reduces immediate liquidity. Answer C fails to recognize that identical current ratios with different quick ratios reveal important differences in liquidity quality.
Remember this pattern: when current ratios are equal but quick ratios differ, focus on inventory levels. The company with the higher quick ratio has less inventory tying up working capital and better immediate liquidity.
