Dallas Corp. has a current ratio of 6, under which of the following scenarios might this indicate a problem
A) inventories are increasing due to the introduction of a new product
B) the company is holding cash in expectation of making a large investment in equipment
C) receivables are increasing due to increasing sales
D) inventories are increasing and the industry in which Dallas Corp. operates is experiencing a recession

Question

Quizplus · Accepted Answer

An increase in inventories combined with a recession in the industry could potentially lead to lower sales and difficulty in selling off excess inventory, which would negatively impact the current ratio. A current ratio of 6 indicates a relatively strong liquidity position, but if the company is not able to convert its assets into cash quickly enough, it could face problems in meeting short-term obligations. The other options (A, B, and C) do not necessarily indicate a problem with the current ratio, as inventory increases due to new products or receivables increases due to sales growth can be positive indicators of future revenue and cash flow. Holding cash in anticipation of a large investment is also not necessarily problematic, as long as the investment generates sufficient returns to justify the expenditure.