Tag: liquidity ratios

Questions Related to liquidity ratios

Purchase of inventory on credit will cause the quick ratio to               .

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. increase

  2. decrease

  3. remain unchanged

  4. none of these

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Correct Option: B
Explanation:

Quick Ratio = [Current assets minus Inventory] / Current liabilities

Let Current assets = $Rs. 100000$, Inventory = $Rs. 20000$ and Current liabilities = $Rs. 40000$
 So Quick Ratio = [$100000-20000] / 40000$ = $2 : 1$
Now let inventory purchased on credit be $Rs. 20000$, so revised Inventory = $Rs. 60000$ and Current liabilities = $Rs. 60000$
Revised Quick Ratio =[$100000-60000] / 60000$ = $2 : 3$
So , Purchase of inventory on credit will cause the quick ratio to decrease.

Which of the following transactions will change the current ratio?

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  1. Purchase of goods for cash.

  2. Plant acquired on account.

  3. Sold goods on credit.

  4. Debentures converted into equity capital.

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Correct Option: B
Explanation:
  1. When goods are purchased for cash the stock would increase and the cash balance would decrease and so there would be no effect on the current ratio.
  2. When plant is acquired on account the fixed asset would increase and there would be increase in the creditors amount, hence the current ratio would decrease.
  3. When goods are sold on credit the stock would decrease and the debtors would increase and hence there would be no effect on current ratio.
  4. When debentures are converted into equity capital there would be no changes in current assets and current liabilities  and so no change in current ratio.

The immediate solvency ratio is                 .

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  1. quick ratio

  2. current ratio

  3. stock turnover ratio

  4. debtor turnover ratio

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Correct Option: A
Explanation:

Quick Ratio = [Current Assets- Inventory] / [Current liabilities - Bank Overdraft and Cash credit]

While calculating quick ratio we reduce the amount of inventory as it is less liquid than the other current assets. The reason to reduce the amount of bank overdraft and cash credit is that mostly these are secured against inventory. So quick ratio gives us an immediate solvency ratio and is a much more conservative ratio than current ratio.

Current ratio is increased by :
1) Issue of redeemable debentures.
2) Selling of old machine for cash.
3) Converting debentures into equity capital.
4) Cash received from debtors.

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  1. 1, 2 and 4

  2. 3 and 4

  3. 1 and 2

  4. 4 only

Show answer
Correct Option: C
Explanation:

Current ratio = Current assets/ Current liabilities

  1. When Redeemable debentures are issued, long term liabilities and the current assets increase,while  the current liabilities remain constant so  the current ratio would increase.
  2. When old machine is sold for cash, fixed assets would decrease and the current assets would increase, while  the current liabilities remain constant so  the current ratio would increase.
  3. When debentures are converted into equity capital there would be no changes in the current assets and the current liabilities and ultimately no change in the current ratio.
  4. When cash is received from debtors there would be no net changes on the current assets as the cash balance would increase and the debtors balance would decrease by the same amount and hence there would no change in the current ratio.

Current ratio may be increased by                    .

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  1. Overstating the current assets

  2. Overstating the current liabilities

  3. Understating current assets

  4. None of these

Show answer
Correct Option: A
Explanation:

Current ratio = Current assets/ current liabilities

So when current assets = $Rs 150000$ and current liabilities = $Rs. 100000$ then,
Current ratio = $100000 / 50000$
                       = $2 : 1$
Now if we overstate the current assets by $Rs. 50000$ then ,
Revised Current ratio = $150000/50000$
                                     = $3: 1 $
So, the current ratio may be increased if we overstate the current assets. 

The ability of a company to meet its short-term obligations known as                     .

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  1. Liquidity

  2. Solvency

  3. Profitability

  4. Trading on equity

Show answer
Correct Option: A
Explanation:

Liquidity refers to both an enterprise's ability to pay short-term obligations and a company's capability to sell assets quickly to raise cash.

Given current ratio = $2.5$
Quick ratio = $1.5$
Net working capital = Rs $30,000$
What is the amount of current liabilities?

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. $Rs20,000$

  2. $Rs30,000$

  3. $Rs50,000$

  4. $Rs60,000$

Show answer
Correct Option: A
Explanation:
Net working capital = Current assets - Current liabilities
$Rs. 30000$ = Current assets - Current liabilities
Therefore, Current assets = Current liabilities + $Rs. 30000$
Current ratio = Current assets/ Current liabilities
$2.5$ = [Current liabilities + $Rs. 30000$] / Current liabilities
 $2.5$ Current liabilities  = Current liabilities + $Rs. 30000$
Current liabilities = $Rs. 30000/ 1.5$
Therefore, Current liabilities = $Rs. 20000$

Given current ratio = $2.5$
Quick ratio = $1.5$
Net working capital = Rs $30,000$
What is the amount of quick assets?

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. $Rs 20,000$

  2. $Rs 30,000$

  3. $Rs 50,000$

  4. $Rs 60,000$

Show answer
Correct Option: B
Explanation:
Net working capital = Current assets - Current liabilities
$Rs. 30000$ = Current assets - Current liabilities
Therefore, Current assets = Current liabilities + $Rs. 30000$
Current ratio = Current assets/ Current liabilities
$2.5$ = [Current liabilities + $Rs. 30000$] / Current liabilities
 $2.5$ Current liabilities  = Current liabilities + $Rs. 30000$
Current liabilities = $Rs. 30000/ 1.5$
Therefore, Current liabilities = $Rs. 20000$
Now,
Current assets = Current liabilities + $Rs. 30000$
                          = $Rs.20000 + Rs. 30000$
                          =$Rs. 50000$
Now, Quick Ratio = Quick Assets/ Current liabilities
                     $1.5$   = Quick Assets/ $20000$
Therefore,
                  Quick Assets = $Rs. 30000$

Quick assets include which of the following?

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  1. Cash

  2. Accounts Receivable

  3. Inventories

  4. Only (a) and (b)

Show answer
Correct Option: D
Explanation:

Quick assets are assets that can be converted to cash quickly. Typically, they include cash, accounts receivable, marketable securities, and sometimes (not usually) inventory.

Current liabilities of a company were Rs. 1,75,000 and its current ratio was 2: 1. It paid Rs. 30,000 to a creditor. Calculate current ratio after payment :

elements of accounts ratio analysis liquidity ratios accounting ratio's accounting ratios

  1. 2: 1

  2. 1: 1

  3. 1: 5: 1

  4. 2.21: 1

Show answer
Correct Option: D
Explanation:

Given,
Current liabilities = Rs-1,75,000
Current Ratio = 2:1

If 30,000 is paid to a creditor it will reduce both current assets as well as current liabilities as cash is being paid and creditors are reduced. Hence, new ratio will be:- 

Current Ratio = Current Assets
                       -------------------------     
                        Current liabilities

                      =  3,50,000 (WN 1) - 30,000

                         --------------------------------------
                           1,75,000 - 30,000
                      = 3,20,000
                          --------------
                          1,45,000
                     = 2.2 : 1

Working note 1) = Current assets 
Current Ratio = Current Assets

                       -------------------------     
                        Current liabilities
Current Assets = Current liabilities x current ratio 
                         = 1,75,000 x 2
                         = 3,50,000.