Question

For a firm that presently has a current ratio of 2.0, the effect on this ratio of paying a current liability is that it:

1) raises the current ratio.
2) lowers the current ratio.
3) doesn't affect the current ratio.
4) depends on the amount paid.

Answer 1

Paying a current liability may raise the current ratio of a firm.

Step-by-step explanation:

When a firm pays a current liability, the effect on the current ratio depends on the amount paid. To understand this, let's assume that the firm has $100 of current assets and $50 of current liabilities, resulting in a current ratio of 2.0 (current assets / current liabilities = 2.0).

If the firm pays off $20 of current liabilities, the current assets would remain the same, but the current liabilities would decrease to $30. The new current ratio would be $100 (current assets) / $30 (current liabilities) = 3.33, which is higher than the original ratio of 2.0. Therefore, paying a current liability would raise the current ratio.