Question

Determine the effect on the current ratio, quick ratio, net working capital (current assets minus current liabilities), the debt ratio (total liabilities to total assets) of each of the following transactions. Consider each transaction seperately and assume that prior to each transaction the current ratio is 1.8x, the quick ratio is 1.5x, and the debt ratio is 75%. Think about what is included in each portion of the ratio. Use "I" for increase, "D" for decrease, and "N" for no change.

Transaction

A) Receives a $15,000 payment from a customer from a previous sale.

B) Writes off $5,000 in obsolete inventory.

C) Writes off $4,000 in bad debt.

D) Purchases $23,000 in raw materials on credit.

E) Makes a $2,000 profitable sale for cash.

F) Sells $45,000 in fixed assets (assume sale price equals book value).

Answer 1

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Particulars	Current ratio	Quick ratio	Net working capital	Debt ratio	Assumption
A) Receives a $15,000 payment from a customer from a previous sale.	N	N	N	N	If payment is received then cash will increase and accounts receivable will decrease. So Total assets will remain same and there is no impact on liabilities. So no change in any ratios.
B) Writes off $5,000 in obsolete inventory.	D	N	D	I	If obsolete inventory written off then, current assets and total assets will reduce but no impact on liabilities. So current ratio and net working capital will decrease and debt ratio will increase.
C) Writes off $4,000 in bad debt.	N	N	N	N	If bad debt written off then it will not impact assets or liabilities as we already take provision for uncollectible debts. So no change in any ratios.
D) Purchases $23,000 in raw materials on credit.	I	N	I	N	If inventory purchased in credit then, current assets, total assets, current liabilities and total liabilities will increase. So current ratio and net working capital will increase and debt ratio will remain same.
E) Makes a $2,000 profitable sale for cash.	I	I	I	D	If sale is done cash will increase. So Total assets will increase and there is no impact on liabilities. So current ratio, quick ratio and net working capital will increase but as total assets will increase so debt ratio will decrease.
F) Sells $45,000 in fixed assets (assume sale price equals book value).	I	I	I	N	If sale is done cash will increase. So Total assets will remain same and there is no impact on liabilities. So current ratio, quick ratio and net working capital will increase but debt ratio will remain same.