Company A has a Current Ratio of 2.0 and a Quick Ratio of 1.0. It uses $50,000 of cash to pay off $50,000 of Accounts Payable. How do the ratios change immediately after this transaction?

Answer options:

Current Ratio increases; Quick Ratio decreases.

Current Ratio increases; Quick Ratio remains unchanged.

Both ratios increase.

Current Ratio decreases; Quick Ratio increases.

How to approach this question

Plug in hypothetical numbers. If Ratio > 1, reducing both sides increases the ratio. If Ratio < 1, reducing both sides decreases it. If Ratio = 1, it stays the same.

Full Answer

B.Current Ratio increases; Quick Ratio remains unchanged.✓ Correct

Current Ratio (starts > 1): Reducing numerator and denominator by same amount increases the ratio. Quick Ratio (starts = 1): Reducing numerator and denominator by same amount leaves ratio at 1.

Common mistakes

Assuming paying debt always improves all liquidity ratios.

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