Current Ratio

Liquidity Ratios:

• Assess whether a business has sufficient cash or equivalent current assets to be able to pay its debts as they fall due

Examples of financial statements:

Incomes Statement:

• Measures business performance over a given period of time, usually one year. It compares the income of the business against the cost of goods or services and expenses incurred in earning that revenue

Statement of Financial Position (Balance Sheet):

• A snapshot of the business’ assets (what it owns or is owed) and its liabilities (what it owes) on a particular day

Cash Flow Statement:

• This shows how the business has generated and disposed of cash and liquid funds during the period under review

Liquidity is determined by the relationship between Current Assets and Current Liabilities:

• Current Assets/ Current Liabilities

Evaluating the Current Ratio:

• A ratio of 1.5-2.5 would suggest acceptable liquidity and efficient management of working capital

• A low ratio (e.g. well below 1) indicates possible liquidity problems

• High ratio: too much working capital tied up in inventories or debtors?

Top Grade Evaluation of Current Ratio:

• The industry or market matters

  • Firms have different requirements for holding inventories or approaches to trade competitors.

  • How does the current ratio compare with competitors?

• The trend is more important

  • A sudden deterioration in the current ratio is a good indicator of liquidity problems

Current Asset Examples:

1. Cash

2. Stock Inventory

3. Accounts Receivables (Invoices)

Max: Twice the assets than liabilities

Minimum: 1 asset to .5 liabilities