Question

Explain how the current ratio can be easily manipulated and provide a detailed illustration and example of how it can be manipulated.

Answer 1

Current ratio can be easily manipulated by equal increase or equal decrease in current assets & current liabilities.

Example,

Before manipulation,

Current assets = $1,50,000

Current liabilities = $90,000

Current ratio = Current assets / Current liabilities

Current ratio = $1,50,000 / $90,000

Current ratio = 1.67

After manipulation,

If both current assets & current liabilities are reduced by 10,000, then manipulated ratio is

New current assets = $1,50,000 - $10,000 = $1,40,000

New current liabilities = $90,000 - $10,000 = $80,000

New current ratio = $1,40,000 / $80,000

New current ratio = 1.75

Current ratio has increased by 0.08 (1.75 - 1.67) due to equally decrease in current assets & current liabilities.