Business – 10.4 Finance and accounting strategy – Accounting data and ratios | e-Consult
10.4 Finance and accounting strategy – Accounting data and ratios (1 questions)
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Economies of scale can affect liquidity ratios in several ways:
- Improvement of the current ratio – As a business grows, it may acquire larger warehouses or negotiate longer credit terms with suppliers, increasing current assets (stock, receivables) relative to current liabilities. For example, bulk purchasing can raise inventory levels, boosting the numerator of the current ratio.
- Deterioration of the quick ratio – If growth is financed by short‑term borrowing or if the company holds a larger proportion of stock (which is excluded from the quick ratio), the quick ratio may fall. Rapid expansion often requires additional working‑capital loans, raising current liabilities faster than cash and receivables.
- Positive impact on both ratios – Efficient production can free up cash flow, allowing the firm to settle payables promptly and increase cash balances, thereby raising both ratios.
- Negative impact on both ratios – Aggressive market entry may lead to high promotional costs and increased accounts payable, reducing cash and receivables while inflating current liabilities, which would lower both ratios.
Thus, while economies of scale can enhance liquidity by improving cash generation, the financing choices and inventory policies adopted during growth determine whether the current and quick ratios ultimately improve or deteriorate.