Which of the following statements is CORRECT?
A)A reduction in inventories held would have no effect on the current ratio.
B)An increase in inventories would have no effect on the current ratio.
C)If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will increase.
D)A reduction in the inventory turnover ratio will generally lead to an increase in the ROE.
E)If a firm increases its sales while holding its inventories constant, then, other things held constant, its inventory turnover ratio will decrease.

Question

Quizplus · Accepted Answer

The current ratio is calculated as current assets divided by current liabilities. Inventories are included in current assets, so a reduction in inventories would decrease current assets and therefore decrease the current ratio, while an increase in inventories would increase current assets and therefore increase the current ratio. An increase in sales while holding inventories constant would increase the cost of goods sold and therefore increase the numerator in the inventory turnover ratio calculation, leading to an increase in the ratio. A reduction in the inventory turnover ratio would indicate that the firm is holding onto inventory for a longer period of time without selling it, which would decrease the cost of goods sold and therefore decrease net income, leading to a decrease in ROE.

Which of the Following Statements Is CORRECT