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Current Ratio

Current Ratio Assignment / Homework Help
One of the most commonly used ratios to measure the short term liquidity position of a business is the current ratio. It measures the ability of a business to pay its short term obligations (generally less than a year) with its short-term resources. The current ratio is computed as:

Current Assets
Current Liabilities

Current Assets include inventories, sundry debtors, cash and bank balances, receivables/accruals, loans and advances, disposable investments, etc.

Current Liabilities include creditors for goods and services, short-term loans, bank overdraft, cash credit, outstanding expenses, provision for taxation, proposed dividend, unclaimed dividend, etc.

A current ratio of 2 to 1 is generally considered good/acceptable. However, this depends more on the type of industry in which the company operates. A ratio of less than 1 indicates that the company does not have enough liquid assets to settle its current obligations. While a ratio of less than 1 is definitely not a good sign for the business, it does not indicate that the company will be bankrupt as it may still have alternative sources of finance to tap to pay its obligations. Current ratio also provides an indication of the efficiency of the operating cycle of the business. In interpreting the current ratio care should be taken in looking into composition of current assets. A firm which has a large amount of cash and account receivable is more liquid than a firm which has high amount of inventories in its current assets, though both the firm may have the same current ratio. To overcome this is a more stringent form of liquidity ratio referred to as quick ratio cab be calculated.

An Example

Compute Current Ratio from the information given below:

Current assets: Current liabilities:
Inventories $20,000 Accounts payable $18,000
Sundry debtors 5,000 Short-term loan 15,000
Cash on hand 12,000 Bank overdraft 5,000
Cash at bank 8,000 Outstanding expenses 3,000
Accounts receivables 35,000 Provision for taxation 10,000
Short-term investments 15,000 Proposed dividends 12,000
95,000 63,000

Current ratio: Current assets / Current liabilities
95,000 / 63,000

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