Accounting · Ratio Analysis
A firm displays a Current Ratio of 2.5 : 1, which is higher than the industry average, but its Quick Ratio (Acid-Test Ratio) is only 0.6 : 1. Which of the following interpretations best explains the liquidity risk associated with these ratios?
Verified Solution4 OptionsUpdated: October 2026👁️1 View
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- 1The wide gap between the two ratios is a normal mathematical outcome of utilizing a Just-In-Time (JIT) inventory system.
- 2The difference between the ratios is irrelevant because total net worth is the primary measure of liquidity.
- 3The low Quick Ratio suggests that a massive portion of current assets is tied up in slow-moving inventory, which may not be easily convertible into cash.✓
- 4The high Current Ratio indicates excellent liquidity and suggests a very low credit risk.
Correct answer
The low Quick Ratio suggests that a massive portion of current assets is tied up in slow-moving inventory, which may not be easily convertible into cash.
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