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Current Ratio (also called – working capital ratio):
Indicates in percentage terms the working capital (i.e. current assets – current liabilities) with which the company conducts its business operations.Current assets include cash and liquid assets that can be readily converted to cash such as accounts receivable, inventory, marketable securities, prepaid expenses etc. Similarly current liabilities are obligations of a company which are due within one year and include short term debt, accounts payable, accrued liabilities and other debts of similar nature.
What is an Ideal Current Ratio?
Higher Current Ratio means higher short term liquidity comfort level. A Current Ratio below 1 shows that the company may not be able to meet its obligations in the short run. However, it is not always a matter of worry if the Current Ratio temporarily falls below 1 as companies often squeeze out short term cash sources to achieve a capital intensive plan with a long term outlook.
The new schedule VI to the companies act now requires all companies to disclose the current assets and current liabilities under separate heads on the balance sheet making it easy to calculate the Current Ratio and measure the working capital available to the company.
An Ideal Current Ratio is between 1 – 1.2. As stated above, if the current ratio stays below 1 for a prolonged period of time, it may be a cause of concern. At the same time, a current ratio higher than 1.5 indicates that the company is not productively utilizing its cash resources.
Click here to go to Liquidity and Credit Ratios (Part 2) – Long term debt equity ratio
About the Author
Rajat Sharma is a well known stock market analyst and commentator. He has covered Indian markets for over a decade and is regarded for consistently identifying early stage investment opportunities. Attorney by qualification, Rajat has done extensive work for improving corporate governance and disclosure standards.Follow @SanaSecurities