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Current Ratio: by Roll No.: A-05

The current ratio measures a company's ability to pay short-term obligations by comparing its current assets to its current liabilities. It is calculated by dividing the current assets by the current liabilities. A current ratio of less than 1 indicates the company may have issues meeting short-term debts, while a ratio greater than 1 suggests the company is in a strong financial position to meet short-term obligations. A ratio of 2:1 is considered the banker's rule of thumb, while a ratio of 3:1 may indicate the company is not efficiently using its current assets. The current ratio provides a crude measure and does not consider the quality or liquidity of current assets.

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340 views3 pages

Current Ratio: by Roll No.: A-05

The current ratio measures a company's ability to pay short-term obligations by comparing its current assets to its current liabilities. It is calculated by dividing the current assets by the current liabilities. A current ratio of less than 1 indicates the company may have issues meeting short-term debts, while a ratio greater than 1 suggests the company is in a strong financial position to meet short-term obligations. A ratio of 2:1 is considered the banker's rule of thumb, while a ratio of 3:1 may indicate the company is not efficiently using its current assets. The current ratio provides a crude measure and does not consider the quality or liquidity of current assets.

Uploaded by

akashbansode34
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© © All Rights Reserved
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`

CURRENT RATIO
By Roll No.: A-05

DEFINITION

Current ratio is type of liquidity ratio which measures companys


ability to pay its short term obligations.
To measure this ability , current ratio considers total current assets
of a company relative to that of total current liabilities of a
company.
FORMULA:

Current Ratio =

CURRENT ASSET : Current Asset is that entity on a balance sheet


which can be converted to cash within a year
For example: Cash in hand
Cash at Bank
Prepaid Expense
Accounts Receivable, etc.
CURRENT LIABILITY : Current liability is the amounts due to be
paid to the creditor back within a year.
For example : Short term loans
Accounts payable
Tax payable, etc
`

CASES
1. Current Ratio < 1
For example : Suppose Company ABC Ltd. has Current assets of
Rs.25000 and Current Liabilities of Rs.50000, So the Current Ratio of
Company ABC Ltd. is
25000
Current Ratio =
50000

= 0.5
So, as current ratio is less than 1 so we can say that company is not in a
good financial condition.

2. Current Ratio > 1


For Example : Suppose Company XYZ Ltd. has Current assets of
Rs.75000 and Current Liabilities of Rs.50000, So the Current Ratio of
Company XYZ Ltd. is
75000
Current Ratio =
50000

= 1.5
So, as current ratio is greater than 1 so we can say that company is in a
good financial condition.
`

3. Current Ratio 2:1( meaning that the current assets twice as large as
current liabilities) is known as Bankers rule of thumb ratio or
Arbitrary Standard of Liquidity for firm.
4. Current Ratio 3:1 is not a good sign for a firm as this means that
company is not using its current assets efficiently.
LIMITATIONS:
1. It is a crude ratio as it measures only quantity and not quality of a
current asset.
2. It also considers those current assets that cannot be liquidated
within a year. For example: Inventories, Prepaid Expense etc.
3. Some businesses have different trading activities in different
seasons. Such businesses may show low current ratio in some
months of the year and high in others.

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