CURRENT RATIO

CURRENT RATIO


This ratio is an indicator of the firm’s commitment to meet its short-term liabilities. The ratio establishes a relationship between current assets and current liabilities.


Objectives:- The objective of computing this ratio is to measure the ability of the firm to meet its short term obligations and to reflect the short term financial strength of the firm.



Formula:-

Current Ratio = Current Assets
Current Liabilities



Here current assets are those assets which are converted into cash within a year. It includes the following: cash balances, marketable securities, bills receivable, payment of tax reduced at source, bank balance, stock, debtors, etc…


Current liabilities are those liabilities which are expected to be matured within a year and include the following: creditors, bills payable, short term loans and advances, provision for tax, bank overdraft, income received in advance, unclaimed dividend etc…


Changes in current ratio:-


The relationship between current assets and current liabilities is disturbed on account of a number of factors. They are as under:


1. Seasonal changes in the business


2. Over Trading: this results in accumulation of the stock and mounting up of debtors and creditors balances


3. Repayment of long-term liability


4. A change made in the terms of trade


Significance:-
The current ratio is an index of the concern’s financial stability since it shows the extent of the working capital which is the amount by which the current assets exceed the current liability.


As stated earlier a higher current ratio would indicate inadequate employment of funds while a poor current ratio is a danger signal to the management. It shows that the business is trading beyond its resources.