Considered alone, which of the following would decrease a company’s current ratio? a. An increase in accounts receivable. b. A decrease in accrued liabilities. c. An increase in accounts payable. d. An increase in net fixed assets.
The correct answer and explanation is:
The correct answer is d. An increase in net fixed assets.
The current ratio is a financial metric that measures a company’s ability to pay its short-term liabilities with its short-term assets. It is calculated by dividing current assets by current liabilities. The formula is:
Current Ratio = Current Assets / Current Liabilities
Let’s break down each option:
- a. An increase in accounts receivable: Accounts receivable is a current asset. If it increases, current assets increase, which would likely increase the current ratio, not decrease it.
- b. A decrease in accrued liabilities: Accrued liabilities are current liabilities. A decrease in them means the company has fewer short-term obligations. This would generally increase the current ratio since current liabilities have decreased.
- c. An increase in accounts payable: Accounts payable is also a current liability. If it increases, current liabilities increase, which would decrease the current ratio. However, this effect is less significant than an increase in net fixed assets.
- d. An increase in net fixed assets: Net fixed assets (e.g., property, plant, and equipment) are non-current assets. An increase in net fixed assets would not affect current assets but would increase the total assets on the balance sheet. Since fixed assets are not part of current assets, the current ratio would decrease because the denominator (current liabilities) remains the same, but current assets (the numerator) are unchanged.
In summary, an increase in net fixed assets would decrease a company’s current ratio because it involves an increase in non-current assets, which do not help in covering short-term liabilities. The current ratio reflects liquidity, and liquidity is only impacted by current assets and current liabilities.