A firm's current assets and current liabilities are Rs. 1600 and Rs. 1000, respectively. How much can it borrow on a short-term basis without reducing the current ratio below 1.25?

Question

Question

This question was previously asked in

UGC NET Paper 2: Management 30th Sep 2020 Shift 1

Answer 1

Current Ratio:

The current ratio measures the ability of a company to pay its short-term obligations.
The ratio indicates whether the company has sufficient funds to pay off its liabilities over a period of 12 months.
The current ratio can be calculated by using the formula = Current assets / Current liabilities
An ideal current ratio ranges from 1.2 to 2. The ratio denotes that the company has 1.2 / 2 times more current assets than its liabilities to cover its debts.

In the above question,

Current asset- Rs 1600

Current liabilities- Rs 1000

Current Ratio = 1.25

Current assets / Current liabilities = Current Ratio

Amount of borrowing be x. (Current Asset will increase because borrowing will increase the cash amount).

(1600 + x)/(1000 + x) = 1.25

(1600 + x) = 1.25(1000 + x)

1600 + x = 1250 + 1.25 x

0.25x = 350

x = 1400

Thus, the company can borrow Rs 1400 on a short-term basis without reducing the current ratio below 1.25.