Why is it A?

[Philly1616]

Cash that normally would have been used to pay the firm's accounts payable is used instead to pay off some of the firm's long-term debt. This will cause the firm's:

A) quick ratio to fall.

B) current ratio to rise.

C) payables turnover to rise.

D) cash conversion cycle to lengthen


Why is the answer "A"?

 

[Super I]

EXAMPLE:

Before:

Assets
Cash 100

Liabilites and equity
AP 10
LTD 30
Equity 60


Current (and quick) ratio is 100/10 or 10

After you pay off LTD:

Assets
Cash 70

Liabilites and equity
AP 10
Equity 60

Current (and quick) ratio is 70/10 or 7


The quick ratio fell from 10 to 7. If you lower the numerator in the ratio without doing anything to the denominator, the value of the ratio falls.

 

[AnalystForum]

Quick Ratio = (Current Assets-Inventory)/Current Liabilities

Since you are removing some of the current assets (i.e. cash) and nothing from the current liabilities, the ratio will be smaller.

Hope this helps.

Chad

 

[Philly1616]

yeah, but the question says that cash that normally would've been used is now used to pay long term debt... so the cash is not really reduced is just moved to a different liability

 

[Philly1616]

that's right... it's just CURRENT liabilities. THANKS!!!

 

[AnalystForum]

The cash is used in both cases, it's just being used to reduce a non-current liability in this example.