Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than B's.

Question

BlackTom AI · Accepted Answer

The statement to evaluate involves two assertions about the relationships between current and quick ratios for firms A and B. We will examine each answer option in turn.

Option 1: True. This option claims that if Firm A's quick ratio exceeds Firm B's quick ratio, then Firm A's current ratio must also exceed Firm B's current ratio.
- At first glance, one might think that higher liquidity in the quick ratio would carry over to a higher current ratio. However, the quick ratio is (current assets minus inventories) divided by current liabilities, while the current ratio is (current assets) divided by current liabilities. A firm can have a very high quick ratio due to substantial liquid assets relative to liabilities, yet still have a relatively low current ratio if its total current assets are not large enough because it holds little or no inventory. Conversely, a firm could have a large amount of inventory contributing to a high current ratio, but its quick ratio could be lower if its liquid assets are not as strong. Hence, there is no guaranteed implication that a higher quick ratio for A compared to B implies a higher current ratio for A compared to B. This shows the statement in Option 1 is not universally true.

Option 2: False. This option asserts that the above implication is not guaranteed, and that is indeed correct.
- A concrete counterexample demonstrates the possibility: imagine Firm A has very low current assets but also very low inventories, giving it a high quick ratio, while Firm B has a larger level of inventories that boost its current ratio even if its quick ratio is lower. In such a case, A can have a higher quick ratio than B while A's current ratio is still not larger than B's current ratio. This shows the conditional claim does not hold in all scenarios.
- Another way to frame it: since the quick ratio excludes inventories, differences in inventory levels can cause the quick ratio comparison to diverge from the current ratio comparison. Therefore, A having a higher quick ratio than B does not guarantee A's current ratio is higher than B's.

Putting it together, the reasoning shows that the proposed universal implication in the statement is not reliable, so the correct choice is False.

Business Finance Chapter 04 Quiz

Even though Firm A's current ratio exceeds that of Firm B, Firm B's quick ratio might exceed that of A. However, if A's quick ratio exceeds B's, then we can be certain that A's current ratio is also larger than B's.

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