Question

The current ratio (CR) measures the corporation’s ability to cover its short-term (ST) maturing liabilities with current assets (CA).

Is it better to have a higher CR to the industry average or is it better to have a lower CR? Explain your answer

When inventories increase, what effect will this have on the CR, potential profitability, and risk to the firm as a result? Explain.

When accounts payable (AP) drop, what effect will this have on the CR, potential profitability, and risk to the firm as a result? Explain

Answer 1

It is better to have higher current ratio than the industry average as it's weakness will lead to difficulty in comparing measures across industry groups and also lead to lack of trending information in the industry.

Increse in inventory increases the current ratio provided it can be easily sold wheras higher inventory storage can reduce profit by storage charges and insurance and there is a risk of price reductions and change in demand of customers.

Decrease in accounts payable increases the current ratio.It increases profitability by non payment of any interest and further is no risk of default in payment of accounts payable.