ExpertHard2 marksShort Answer
Interpretation of Financial StatementsSyllabus HInterpretation of Financial StatementsRatiosLiquidity
ACCA · Question 13 · Interpretation of Financial Statements
Section A
GreenEnergy Ltd has a quick ratio (acid test) of 0.8:1 and a current ratio of 1.5:1. The company uses cash to pay off $50,000 of its trade payables. Will the quick ratio increase, decrease, or remain unchanged?
Section A
GreenEnergy Ltd has a quick ratio (acid test) of 0.8:1 and a current ratio of 1.5:1. The company uses cash to pay off $50,000 of its trade payables. Will the quick ratio increase, decrease, or remain unchanged?
How to approach this question
Set up dummy numbers. Let Current Liabilities = 100. Then Quick Assets = 80. Quick ratio = 80/100 = 0.8. Pay off 50: Quick Assets become 30, Current Liabilities become 50. New ratio = 30/50 = 0.6. The ratio decreases.
Full Answer
When the quick ratio is less than 1:1, paying off a current liability with cash reduces both the numerator (cash) and the denominator (current liabilities) by the same absolute amount. Mathematically, this causes the ratio to decrease. For example, if quick assets are 80 and liabilities are 100 (ratio 0.8), paying 50 makes assets 30 and liabilities 50 (ratio 0.6).
Common mistakes
Assuming that paying off debt always improves liquidity ratios.
Practice the full ACCA FA — Financial Accounting Practice Exam 6
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