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CURRENT RATIO
By Roll No.: A-05

DEFINITION

Current ratio is type of liquidity ratio which measures companys

ability to pay its short term obligations.
To measure this ability , current ratio considers total current assets
of a company relative to that of total current liabilities of a
company.
FORMULA:

Current Ratio =

CURRENT ASSET : Current Asset is that entity on a balance sheet

which can be converted to cash within a year
For example: Cash in hand
Cash at Bank
Prepaid Expense
Accounts Receivable, etc.
CURRENT LIABILITY : Current liability is the amounts due to be
paid to the creditor back within a year.
For example : Short term loans
Accounts payable
Tax payable, etc
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CASES
1. Current Ratio < 1
For example : Suppose Company ABC Ltd. has Current assets of
Rs.25000 and Current Liabilities of Rs.50000, So the Current Ratio of
Company ABC Ltd. is
25000
Current Ratio =
50000

= 0.5
So, as current ratio is less than 1 so we can say that company is not in a
good financial condition.

2. Current Ratio > 1

For Example : Suppose Company XYZ Ltd. has Current assets of
Rs.75000 and Current Liabilities of Rs.50000, So the Current Ratio of
Company XYZ Ltd. is
75000
Current Ratio =
50000

= 1.5
So, as current ratio is greater than 1 so we can say that company is in a
good financial condition.
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3. Current Ratio 2:1( meaning that the current assets twice as large as
current liabilities) is known as Bankers rule of thumb ratio or
Arbitrary Standard of Liquidity for firm.
4. Current Ratio 3:1 is not a good sign for a firm as this means that
company is not using its current assets efficiently.
LIMITATIONS:
1. It is a crude ratio as it measures only quantity and not quality of a
current asset.
2. It also considers those current assets that cannot be liquidated
within a year. For example: Inventories, Prepaid Expense etc.
3. Some businesses have different trading activities in different
seasons. Such businesses may show low current ratio in some
months of the year and high in others.