Question

What will be the effect of paying off an accounts payable balance on the current and the acid-test ratios? Assume that both ratios are greater than 1.

Answer 1

Answer:

Both ratios will increase where the accounts payable balance is paid off.

Step-by-step explanation:

The current ratio is given as

Current ratio = Current asset / current liabilities

Where the current assets are asset that can be converted into cash easily ( including cash and cash equivalents) while the current liabilities are liabilities to be settled in a short term, say 1 year.

Acid test ratio is given as

Acid test ratio = (Current asset -  Inventories) / current liabilities

Here, the current assets excludes the assets that are not so easily converted to cash.

From the two formulas stated above, where the accounts payable balance which is an element of the current liabilities is paid off, the current liabilities balance reduces thus resulting in an increase in both ratio.

Hence, current and the acid-test ratios will increase where the accounts payable balance is paid off.