Final answer:
Paying off a current liability can either keep the current ratio the same or increase it, depending on the relative decrease in current assets and liabilities. If the liability paid is equal to the assets used, the ratio remains unchanged. If the liability is larger, because of factors like accumulated interest, the current ratio will increase, potentially improving the company's liquidity position.
Step-by-step explanation:
When a firm that currently has a current ratio of 2.0 pays off a current liability, it has an impact on this ratio. The current ratio is a liquidity ratio that measures a company's ability to pay off its short-term obligations with its current assets. It is calculated by dividing current assets by current liabilities. As such, if the firm uses its current assets to pay off its current liabilities, both the numerator (current assets) and the denominator (current liabilities) of the current ratio will decrease.
However, the impact on the current ratio depends on the relative sizes of the assets used and the liability paid. If the amount of current assets used is the same as the current liability amount, then the current ratio remains unchanged. If the current assets decrease by a larger amount than the current liabilities, the current ratio will decrease. On the other hand, if the current assets decrease by a smaller amount than the current liabilities, the current ratio will actually increase.
This can happen if, for example, cash (a current asset) is used to pay off a short-term debt (a current liability). If the cash amount is equal to the debt, the ratio stays the same. But if the debt has accumulated interest that is also paid off, the liability decreases more than the assets, thus increasing the current ratio. This could improve the company's liquidity position, making it more appealing to investors and creditors.