Question

Current liabilities of a company were Rs2,00,000 and its current ratio was 2.5 : 1 If the company paid Rs1,00,000 to a trade payable, the current ratio after the payment will be:

• A. 2.5 : 1
• B. 4 : 1
• C. 5 : 1
• D. None of the above

Hint:

Conceptual Rule:
If the current ratio is greater than 1 : 1, payment of a current liability in cash will always increase the current ratio because the percentage decrease in current liabilities is higher than the percentage decrease in current assets.
If the current ratio is less than 1 : 1, payment of a current liability will decrease the ratio.
If it is equal to 1 : 1, payment will leave the ratio unchanged.

Answer 1

The Correct Option is B

Step 1: Understanding the Question:
The question asks us to calculate the new current ratio of a company after it pays Rs1,00,000 to one of its trade payables (a current liability).

Step 2: Key Formula or Approach:
The standard formula for Current Ratio is:
\[ \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} \]

Step 3: Detailed Explanation:

• Calculate Initial Current Assets:
  We are given:
  Current Liabilities = Rs 2,00,000
  Current Ratio = 2.5 : 1
  Using the ratio formula:
  \[ 2.5 = \frac{\text{Current Assets}}{2,00,000} \]
  \[ \text{Current Assets} = 2.5 \times 2,00,000 = Rs 5,00,000 \]
  
• Effect of Payment to Trade Payable:
  The company paid Rs 1,00,000 to a trade payable.
  This payment is made in cash/bank, which is a Current Asset. Therefore, Current Assets will decrease by Rs 1,00,000.
  Trade Payable is a Current Liability. Therefore, Current Liabilities will also decrease by Rs 1,00,000.
  
• Calculate New Current Assets and Current Liabilities:
  \[ \text{New Current Assets} = 5,00,000 - 1,00,000 = Rs 4,00,000 \]
  \[ \text{New Current Liabilities} = 2,00,000 - 1,00,000 = Rs 1,00,000 \]
  
• Calculate New Current Ratio:
  \[ \text{New Current Ratio} = \frac{\text{New Current Assets}}{\text{New Current Liabilities}} = \frac{4,00,000}{1,00,000} = 4 \]
  Thus, the new ratio is 4 : 1.
  

Step 4: Final Answer:
The new current ratio after payment of trade payables is 4 : 1, which corresponds to Option (B).