Current Ratio

By Research Desk
about 9 months ago

The current ratio is the ratio of current assets to current liabilities. Current ratio is a commonly used liquidity ratio to measures company's ability to pay current liabilities from current assets.

Current Ratio = Current Assets / Current Liabilities

Tracking the current ratio and other liquidity ratios helps an investor assess the health of a company. A high current ratio indicates that a company is able to meet its short-term obligations. Current ratio of 2:1 is considered healthy.

Generally, a low current ratio could suggest problems with inventory management, ineffective policy for collecting receivables, or excessive cash burn rate. Increases in the current ratio over time may indicate a company is nearing or reaching its capacity (while a decreasing ratio may indicate the opposite). But remember that big purchases made in preparation for coming growth (or the sale of unnecessary assets) can suddenly and somewhat artificially change a company's current ratio.

Comparison of current ratios is most meaningful among companies within the same industry, and hence definition of ‘high’ or ‘low’ ratio should be made within this context. 

Let us take the extract of balance sheets of two companies in the same industry say JSW Steel and Tata Steel, as of 31-3-2018, and compare their current ratios for better understanding:

Particulars

JSW Steel

Tata Steel

Current Assets

Rs. 19,253 crore

Rs. 34,644 crore

Current Liabilities

Rs. 25,205 crore

Rs. 25,607 crore

Current Ratio

0.76

1.35

In the above case, Tata Steel has a better Current Ratio in comparison to JSW Steel, indicating that Tata Steel will be able to easily service its short term obligations whereas JSW Steel can have issues in doing the same.

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