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    Question

    If the trend of the current ratio is increasing, while

    the trend of the acid-test ratio is decreasing over a period of time, this could be a warning that the firm is:
    A Depleting its inventories Correct Answer Incorrect Answer
    B Having trouble collecting its receivables Correct Answer Incorrect Answer
    C Carrying excess inventories Correct Answer Incorrect Answer
    D Purchasing too much treasury stock Correct Answer Incorrect Answer
    E None of the above Correct Answer Incorrect Answer

    Solution

    When the trend of the current ratio (current assets divided by current liabilities) is increasing, it suggests that the firm's overall liquidity position is improving. On the other hand, when the trend of the acid-test ratio (quick assets divided by current liabilities) is decreasing, it indicates a decline in the firm's ability to meet its short-term obligations without relying on inventory. If the firm is depleting its inventories (option a), it would likely result in a decrease in both the current ratio and the acid-test ratio. Option b, having trouble collecting receivables, would mainly impact the accounts receivable turnover ratio but not necessarily the acid-test ratio. Option c, purchasing too much treasury stock, would not directly impact the liquidity ratios. Therefore, option d, carrying excess inventories, is the most appropriate warning indicated by the given trends. It suggests that the firm may have an inefficient inventory management system or that demand for its products has decreased.

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