One problem with ratio analysis is that relationships can be manipulated. For example, we know that if our current ratio is less than 1.0, then using some of our cash to pay off some of our current liabilities would cause the current ratio to increase and thus make the firm look stronger.
Answer the following statement true (T) or false (F)
False
Rationale: The key here is to recognize that if the CR is less than 1.0, then a given reduction in both current assets and current liabilities would lead to a decrease in the CR. The reverse would hold if the initial CR were greater than 1.0. In the question, the initial CR is less than 1.0, so using cash to reduce current liabilities would lower the CR. If the CR were greater than 1.0, the statement would have been true. Here's an illustration:
| Original | New | Old | New | ||
| CA/CL | Less $1 | CA/CL | CR | CR | |
| 2/3 | ?1/?1 | 1/2 | 0.67 | 0.50 | CR falls if initial CR is less than 1.0 |
| 3/2 | ?1/?1 | 2/1 | 1.5 | 2.0 | CR rises if initial CR is greater than 1.0 |
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