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Business Administration QUESTION #9601
Question 1
A company's current ratio is 2.5 but its quick ratio is 0.6. What does this disparity most critically reveal about the company's liquidity position, and what risk does it pose to short-term creditors?
  • The company is in excellent liquidity health — a current ratio above 2.0 always signals strong ability to meet short-term obligations
  • The company's liquidity is heavily dependent on inventory — if inventory cannot be quickly liquidated (due to obsolescence, market conditions or long conversion cycles), the company may be unable to meet current obligations despite appearing liquid on paper✔️
  • The company has excessive cash holdings that are suppressing the quick ratio — it should invest idle cash in short-term securities
  • The disparity indicates aggressive revenue recognition — the company is booking receivables before cash collection, inflating current assets artificially
Correct Answer Explanation
Current ratio includes inventory; quick ratio excludes it. A current ratio of 2.5 with a quick ratio of 0.6 means nearly all current assets are inventory. If inventory is slow-moving, seasonal or perishable, it cannot reliably convert to cash in time to meet current liabilities. This is precisely the risk creditors face — apparent liquidity that evaporates when inventory cannot be sold, a common precursor to liquidity crises in retail and manufacturing firms.