Question

The Current Ratio of Manas Ltd. is 2 : 1. Which of the following transactions will reduce the current ratio?

• A. Payment to trade payables
• B. Issue of shares
• C. Sale of inventory at a loss
• D. Cash collected from trade receivables

Hint:

Any transaction that reduces total current assets without reducing current liabilities will reduce the current ratio. Loss on sale of inventory does just that.

Answer 1

The Correct Option is C

Step 1: Recall the formula for current ratio: \[ \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} \] Step 2: Let’s examine each option: (A) Payment to trade payables:
Reduces both current assets (cash) and current liabilities (payables) equally.
If current ratio is above 1:1 (here it is 2:1), then this improves the ratio. So, does not reduce it.
(B) Issue of shares:
This brings in cash (increasing current assets) but does not affect current liabilities.
So, increases current ratio.
(C) Sale of inventory at a loss:
Inventory decreases, and cash received is less than book value. So total current assets decrease.
Liabilities remain unchanged \(\Rightarrow\) current ratio falls.
(D) Cash collected from trade receivables:
Just converts one current asset (debtors) into another (cash).
No change in total current assets or liabilities \(\Rightarrow\) no effect on ratio.
\(\Rightarrow\) Only Option (C) results in a fall in current assets without affecting liabilities.