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Deceptive Ratio Positions

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Favorable business operations may bring about certain seemly unfavorable ratios. Unfavorable business operations may result in apparently favorable ratios. For example, a company increased its sales and net income substantially for the current year, yet the current ratio at the end of the year is lower than the beginning of the year.

Discuss some possible causes of the apparent weakening of the current position, while sales and net income have increased substantially. Be specific when naming the factors and explaining why they should be included as a possible cause.

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Solution Preview

Given that sales substantially increased during the year and the company's income also increased, then there could be several reasons why its current position as measured by the current ratio worsens.

First, the current ratio is computed by dividing current assets with current liabilities. Hence, decreases in current assets and increases in current liabilities decrease the current ratio.

Second, ...

Solution Summary

The solution discusses lower current ratio even with increased sales & NI.