Question

The Quick Ratio of a company is 1:1. Which of the following transactions will result in an increase in the Quick Ratio?

Hint:

When analyzing the effect of a transaction on the Quick Ratio, focus on how Quick Assets (Cash, Debtors, Marketable Securities) and Current Liabilities (short-term debts) are impacted. If Quick Assets increase without a corresponding increase in Current Liabilities, the Quick Ratio will increase.

Answer 1

The Quick Ratio, also known as the Acid-Test Ratio, is given by: \[ \text{Quick Ratio} = \frac{\text{Quick Assets}}{\text{Current Liabilities}} \] Where: - Quick Assets = Current Assets - Inventory - Prepaid Expenses - Current Liabilities = Short-term liabilities (debts due within one year) Given that the initial Quick Ratio is 1:1, it means that: \[ \text{Quick Assets (QA)} = \text{Current Liabilities (CL)} \] Now, let's analyze the effect of each transaction: \begin{itemize} \item[(A)] Cash received from debtors:
Cash (Quick Asset) increases, and Debtors (Quick Asset) decrease by the same amount. Since the total Quick Assets remain unchanged and Current Liabilities remain unchanged, the Quick Ratio does not change.
Effect: No increase in the Quick Ratio. \item[(B)] Sold goods on credit:
Selling goods on credit increases Debtors (Quick Asset) while Inventory (Non-Quick Asset) decreases. This increases the total Quick Assets. Since Current Liabilities remain unchanged, the Quick Ratio increases.
Effect: Increases the Quick Ratio. \item[(C)] Purchased goods on credit:
Purchasing goods on credit increases Inventory (Non-Quick Asset) and increases Creditors (Current Liability). Since Quick Assets do not change and Current Liabilities increase, the Quick Ratio decreases.
Effect: Decreases the Quick Ratio. \item[(D)] Purchased goods on cash:
Purchasing goods on cash decreases Cash (Quick Asset) and increases Inventory (Non-Quick Asset). Since Quick Assets decrease while Current Liabilities remain unchanged, the Quick Ratio decreases.
Effect: Decreases the Quick Ratio. \end{itemize} Conclusion: - Option (B) "Sold goods on credit" increases the Quick Ratio because it increases the Quick Assets without affecting the Current Liabilities.