Accounting · Financial Statement Analysis
XYZ Ltd operates in a volatile market. Extracts from its financial statements show: • 20X4: Current Assets = $250,000; Inventory = $100,000; Current Liabilities = $150,000; Long-term Debt = $500,000; Equity = $400,000; Cost of Sales = $800,000; Revenue = $1,200,000 • 20X5: Current Assets = $350,000; Inventory = $180,000; Current Liabilities = $200,000; Long-term Debt = $600,000; Equity = $450,000; Cost of Sales = $950,000; Revenue = $1,400,000 In 20X5, XYZ Ltd secured a new long-term loan to expand its inventory holdings in anticipation of a peak sales season, aiming to reduce stock-outs and take advantage of bulk purchase discounts. Which of the following conclusions best describes the combined impact of XYZ Ltd's strategy on its financial position and efficiency?
Verified Solution4 OptionsUpdated: October 2026👁️1 View
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- 1While the current ratio has improved, the increase in inventory days and gearing highlights a trade-off where improved sales potential comes with higher holding costs and financial risk.✓
- 2A worsening of liquidity and efficiency ratios, coupled with higher gearing, indicates that the strategic decision has negatively impacted the company's short-term financial stability without clear operational benefits yet.
- 3The increase in gearing suggests higher financial risk, but this is justified by the improved efficiency in inventory management as reflected by the quick ratio.
- 4An improvement in liquidity is evident from the increased current ratio, while the declining inventory turnover indicates successful management of inventory levels.
Correct answer
While the current ratio has improved, the increase in inventory days and gearing highlights a trade-off where improved sales potential comes with higher holding costs and financial risk.
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