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      Question

      A company’s quick ratio is 1.2. If inventory were

      purchased for cash, the:
      A numerator would decrease more than the denominator, resulting in a lower quick ratio Correct Answer Incorrect Answer
      B denominator would decrease more than the numerator, resulting in a higher current ratio Correct Answer Incorrect Answer
      C numerator and denominator would change proportionally, leaving the current ratio unchanged Correct Answer Incorrect Answer
      D numerator would increase more than the denominator, resulting in a higher quick ratio Correct Answer Incorrect Answer
      E None of the above Correct Answer Incorrect Answer

      Solution

      Quick ratio = (Current assets – inventory – prepaid expenses)/current liabilities. As the quick ratio includes cash but no inventory, there will be a change in the numerator on account of decrease in cash (which is a current asset). Denominator will remain unchanged. So overall, quick ratio will decrease after this change. For example: if quick ratio is 1.2, and if current assets are 1200 and current liabilities are 1000 (1200/1000 =1.2). if we purchase inventory (let’s say for Rs 100), then it will not make a difference in quick assets which exclude inventory. But they include cash, then there will be a reduction in quick assets. Quick assets then will become: 1200 -100 = 1100. There is no change in a liability here. So new quick ratio will become: 1100/1000 = 1.1. So, clearly answer will be (a). There is a reduction in a numerator and result is a lesser quick ratio as compared to the previous one.

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