Current ratio formula is used to assess the firm’s ability to meet its current liabilities. The relationship of current assets to current liabilities is known as current ratio. The Current ratio is calculated as:
Current Ratio Formula
Current Ratio Formula = (Current Assets / Current Liabilities)
You can do this through Current Ratio Calculator. It makes easier to find what is good current ratio. Current Assets Asset that one can reasonably expect to convert into cash, sell, or consume in operations within a single operating cycle, or within a year if more than one cycle is completed each year. It means assets, which are easily convertible into cash within one year. This includes cash in hand, cash at bank, sundry debtors, bills receivable, short term investment or marketable securities, stock and prepaid expenses.
Current Liabilities are those liabilities which are payable within one year. This includes bank overdraft, sundry creditors, and bills payable and outstanding expenses. It is one of the types of liquidity ratio.
Importance and Advantages of Current ratio
- It explains the ability to repay the short term liabilities quickly.
- Ideal ratio is, expressed in times, 2:1, i.e., 2 would mean that the company has 2 times more current assets than current liabilities. This may vary from industry to industry.
- The very high ratio indicates existence of idle current assets.
- It is more useful for working capital determination. It may also point outs problems in working capital management.
- A higher current ratio is always more favorable than a lower current ratio because it shows the company can more easily make current debt obligations.
- It is useful to get an idea about the efficiency of the operating cycle of the business firm. Thus it shows the ability of a company to convert its products or other assets into cash when required.
Disadvantages of Current Ratio:
- Change in nature within the year: In normal business practice, it have different trading activities in different time. In such a situation, businesses may show different ratios in the year..
- Different accounting policy: while comparing the ratio of two companies, to ensure, both the companies use same accounting policy.
- It tests the volume or value within the firm and not n the quality. The quality of individual asset is not taken into account while computing this ratio.
- It more prone to adjustment by adding value or decreasing to assets or liabilities.
Current ratio gives a good route for shareholders and creditors to understand the liquid position of a business entity. And explains how easily that company will be able to pay off its current liabilities.
Originally posted 2015-01-26 18:42:06.