Company X has a Current Ratio of 2.0 and a Quick Ratio of 1.5. If the company uses cash to purchase inventory, what is the immediate effect on these ratios?

Answer options:

Current Ratio: No Change; Quick Ratio: Decrease

Current Ratio: Decrease; Quick Ratio: Decrease

Current Ratio: No Change; Quick Ratio: No Change

Current Ratio: Increase; Quick Ratio: Decrease

How to approach this question

Write down the formulas. Current Ratio = CA / CL. Quick Ratio = (Cash + AR) / CL. Analyze the transaction: Debit Inventory, Credit Cash. Inventory is in CA but not Quick Assets. Cash is in both.

Full Answer

A.Current Ratio: No Change; Quick Ratio: Decrease✓ Correct

Transaction: Buy Inventory with Cash.<br/>Effect on Current Assets: Cash decreases, Inventory increases by same amount. Net change = 0. Current Ratio = CA/CL = No Change.<br/>Effect on Quick Assets: Cash decreases. Inventory is NOT a quick asset. Quick Assets decrease. Quick Ratio = QA/CL = Decrease.

Common mistakes

Thinking Inventory is a quick asset; failing to realize the swap within Current Assets leaves the total unchanged.

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