Question

Quick Ratio of a company is 2 : 1. State, giving reasons, which of the following transactions would (i) Improve, (ii) Reduce, (iii) Not change the Quick Ratio:

1. Purchase of goods for cash;
2. Purchase of goods on credit;
3. Sale of goods (costing ₹ 20,000) for ₹ 20,000;
4. Sale of goods (costing ₹ 20,000) for ₹ 22,000;
5. Cash received from Trade Receivables.

Answer 1

\[\text{Quick Ratio} = \frac{\text{Quick Assets}}{\text{Current Liabilities}}\]

(a) Purchase of goods for cash

Effect: Reduce

Reason: Cash (a Quick Asset) decreases, while Inventory increases. Since Inventory is not a Quick Asset, total Quick Assets decrease while Current Liabilities remain unchanged.

Example: $\frac{2,00,000 - 10,00,000}{1,00,000} = \frac{1,90,000}{1,00,000} = 1.9 : 1$ (Ratio reduced).

(b) Purchase of goods on credit

Effect: Reduce

Reason: Inventory increases (no effect on Quick Assets), but Creditors/Trade Payables (Current Liabilities) increase. An increase in the denominator decreases the overall ratio.

Example: $\frac{2,00,000}{1,00,000 + 50,000} = \frac{2,00,000}{1,50,000} = 1.33 : 1$ (Ratio reduced).

(c) Sale of goods (costing ₹20,000) for ₹20,000

Effect: Improve

Reason: Cash or Trade Receivables (Quick Assets) increase by ₹20,000, while Inventory (non-quick asset) decreases. Total Quick Assets increase while Current Liabilities remain the same.

Example: $\frac{2,00,000 + 20,000}{1,00,000} = \frac{2,20,000}{1,00,000} = 2.2 : 1$ (Ratio improved).

(d) Sale of goods (costing ₹20,000) for ₹22,000

Effect: Improve

Reason: Cash or Trade Receivables (Quick Assets) increase by the selling price of ₹22,000. This increases total Quick Assets while Current Liabilities remain unchanged.

Example: $\frac{2,00,000 + 22,000}{1,00,000} = \frac{2,22,000}{1,00,000} = 2.22 : 1$ (Ratio improved).

(e) Cash received from Trade Receivables

Effect: No change

Reason: Cash increases and Trade Receivables decrease by the exact same amount. Since both items are part of Quick Assets, total Quick Assets and Current Liabilities remain completely unchanged.