Current ratio is an important financial analysis tool with an aim to determine the liquidity position of any business entity. It is determined by dividing current assets with current liabilities. Generally, for manufacturing and trading businesses, current ratio is preferred to be equal to 2. A current ratio of less than 1 would mean that net working capital is negative, depicting that the firm is facing liquidity problems.
There are certain events that affect current ratio of any business entity. As a student of business finance, discuss impact of the following events on current ratio of a firm.
- Inventory is purchased on credit.
- An outstanding part of a long term bank loan payable in three years paid in full availing a special rebate of 1%.
- A credit customer pays off on a discount of 3%.
- Inventory is sold for a profit.
You may assume that if net working capital is positive, the ratio would be greater than one.
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