Current Ratio

Definition Current Ratio

It’s a type of ratio that tells the company's ability to meet the short-run debt obligations or those due within one year. This ratio measures the capacity of a company to pay off its short-run liabilities (payable, etc.) by liquidating its short-run assets (cash, inventories, etc.)

Formula:

Analyst Interview Current Ratio Formula

View:

  • Current Assets > Current Liabilities, then Ratio is greater than 1 then a favorable situation to be in.

  • Current Assets = Current Liabilities, then Ratio is equal to 1 then Current Assets are just enough to pay down its short term obligations.

  • Current Assets < Current Liabilities, then Ratio is less than 1 then a problem situation at side as the company does not have enough to pay for its short term obligations.


Where to find the data?

Current Assets: In the balance sheet of the company in the current assets.

Current Liabilities: In the balance sheet of the company in the current liabilities.


Pros And Cons Of Current Ratio

Pros:

  • It helps to understand how cash rich a company is. Also it help us in short-term financial strength of a company. Higher the ratio give more stability in the company is. Lower the ratio show greater is the risk of liquidity with the company.

  • It gives an view of a company operating cycle. It also help in understanding how efficient the company is in selling off its products. Thats how company is quickly able to convert its inventory or current assets into cash.

  • It shows the management’s efficiency in meeting the creditor’s demands. It also gives an understanding of working capital management or requirement of the company.

Cons:

  • It includes inventory in the calculation, which may lead to overestimation of the liquidity position in many cases.

  • In some companies where sales are seasonal and possibility to reduced current ratio in some months and increased ratio in the other.

Example:

1) Current Assets = 134,836,000

Current Liabilities = 125,481,000

Cash & Cash Equivalents = 34,940,000

Account Receivables = 51,506,000

Short-Term Investments = 27,699,000


Solution:- Current Assets/Current Liabilities

= 134,836,000/125,481,000

=1.07

Analyst Interview Current Ratio Example