An increase in current liabilities will have which one of the following effects, all else held constant? Assume all ratios have positive values.
A) Increase in the cash ratio
B) Increase in the net working capital to total assets ratio
C) Decrease in the quick ratio
D) Decrease in the cash coverage ratio
E) Increase in the current ratio

Question

Quizplus · Accepted Answer

The quick ratio (also known as acid test ratio) is a measure of a company's ability to pay its current liabilities with its most liquid assets (excluding inventory). Since current liabilities are included in the calculation of the quick ratio, an increase in current liabilities will decrease the ratio, indicating a reduced ability to pay short-term debts.

Option A is incorrect because an increase in current liabilities will reduce the amount of cash available for the company, leading to a decrease in the cash ratio.

Option B is incorrect because an increase in current liabilities will decrease the net working capital, which is the difference between current assets and current liabilities. Therefore, the net working capital to total assets ratio will decrease.

Option D is incorrect because the cash coverage ratio is a measure of a company's ability to pay interest expenses with cash flow from operations. Current liabilities are not directly related to interest expenses.

Option E is incorrect because the current ratio measures a company's ability to pay its current liabilities with its current assets, including inventory. Since inventory is not included in the calculation of the quick ratio, an increase in current liabilities alone will not necessarily cause an increase in the current ratio.

An Increase in Current Liabilities Will Have Which One of the Following