Current Ratio
Current Ratio is a very important liquidity ratio used in both business finance as well as personal finance. It is called so because it considers only current assets and current liabilities.
It is calculated as below:
CURRENT RATIO = CASH OR CASH EQUIVALENTS / SHORT TERM LIABILITIES
In business, this ratio is used to measure a company’s ability to pay its short-term obligations. It indicates how a company can use its current assets on its balance sheet to meet its current debt and other payables. It is also referred to as Working Capital Ratio.
This ratio helps investors understand a company’s ability to meet its short-term debts with its current assets.
For a company, the short-term liabilities are
- Taxes
- Accounts Payable
- Outstanding wages
- Dividends declared
- Debt Repayments etc.
The current assets include
- Cash
- Cash equivalents such as short-term deposits, liquid funds, etc.
- Accounts receivables
- Inventory
- Any assets which can be liquidated immediately
Also read about Liquidity Ratio
Higher Current Ratio indicates that a company is capable of meeting its short-term liabilities. If this ratio is less than one, it indicates that the company has less working capital than required.
In personal finance, this ratio represents your ability to service short-term liabilities in case of any financial emergencies. It represents your ability to service short-term liabilities in case of any financial emergency.
For an individual, current assets include
- Cash or cash equivalent such as cash in hand, cash in the bank, liquid funds, etc.
- Any assets which can be liquidated immediately
Short-term liabilities include
- Total EMI payments that are to be made in the current year
- Credit card outstanding balance
- Any other such obligation which is to be met in the current year
If this ratio is high it means that you can comfortably meet your short-term obligations in case of job loss or any other financial emergency. If it is less than 1, it means that you may not be able to cover your short-term liabilities in a financial emergency.
Example: If your savings account balance is Rs.2 lakhs, and your cash in hand is Rs.1 lakh, then your current assets are calculated to be Rs.3 lakhs. If your loan repayments are Rs.3 lakhs per annum, then the Current Ratio is calculated to be 1 ((2lakhs + 1 lakh)/3 lakhs). It indicates that in case of any financial emergency, you can just meet your short-term obligations.
