Banking · Interpretation of Liquidity Ratios
You are reviewing the loan application of a manufacturing unit that has maintained a constant Current Ratio of 1.50 over three years. However, its Quick Ratio declined from 1.10 to 0.70 during the same period. The company states this is due to bulk raw material purchases to prevent future price impacts. How should a credit analyst interpret this divergence?
Verified Solution4 OptionsUpdated: October 2026👁️1 View
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- 1The Quick Ratio is irrelevant for manufacturing firms since high inventory levels are mandatory.
- 2Buying in bulk improves long-term profitability, so the declining Quick Ratio can be ignored.
- 3The widening gap and declining Quick Ratio suggest that a significant portion of current assets is locked in inventory, increasing liquidity risk.✓
- 4The stable Current Ratio indicates that the overall liquidity of the firm is intact and there is no cause for concern.
Correct answer
The widening gap and declining Quick Ratio suggest that a significant portion of current assets is locked in inventory, increasing liquidity risk.
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