What is Current Ratio?
It is a liquidity ratio through which we can identify company’s ability to pay its short-term obligation or those that are due in 1 year.
This ratio is also called Working Capital Ratio which shows relatnshp betwn Current Asset & Current Liabilities.
It is a liquidity ratio through which we can identify company’s ability to pay its short-term obligation or those that are due in 1 year.
This ratio is also called Working Capital Ratio which shows relatnshp betwn Current Asset & Current Liabilities.
The formula is:
Current Ratio = Current Asset - Current Liabilities
Here, CA includes cash & those assets which can be easily converted into cash in a short period of time. For Eg, debtor, B/R stock, prepaid exp, etc.
Current Ratio = Current Asset - Current Liabilities
Here, CA includes cash & those assets which can be easily converted into cash in a short period of time. For Eg, debtor, B/R stock, prepaid exp, etc.
CL include obligations payable within 1 year such as creditors, B/P, Taxes, Dividends payable, etc.
The ideal Current ratio is 2:1. While calculating this ratio, we must compare it with the current ratio of its peer companies to get the full & clear picture.
The ideal Current ratio is 2:1. While calculating this ratio, we must compare it with the current ratio of its peer companies to get the full & clear picture.
Importance of Current Ratio:
• This ratio is used by creditors to evaluate whether a company can be offered short-term debts.
• It also provide info abt company’s operating cycle
• It shows company’s ability to convert its asset into cash to pay off its short-term debts
• This ratio is used by creditors to evaluate whether a company can be offered short-term debts.
• It also provide info abt company’s operating cycle
• It shows company’s ability to convert its asset into cash to pay off its short-term debts
Limitations of Current Ratio:
• This ratio only tells us the quantity of assets & not the quality
• It can easily be manipulated by overvaluing the current assets
• This ratio only tells us the quantity of assets & not the quality
• It can easily be manipulated by overvaluing the current assets
• This ratio cannot tell whether a company is receiving timely payment from its customers
• Several liabilities can be neglected for reporting a good current ratio
• Several liabilities can be neglected for reporting a good current ratio
It is not necessary that this ratio always represents a company’s complete liquidity or solvency. There are certain other factors also thats equally imp while analysing companies.
Therefore, learning more ratios & financial concepts is necessary to perform gud research & this is where Quest’s Value Investing course comes to the rescue - bit.ly/quest-bse-valu…
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