Liquidity - Current Ratio

• How do you calculate current ratio?

  Current assets / current liabilities
• What are examples of current assets?

  • Cash
  • Stock/inventories
  • Trade receivables
• What are examples of current liabilities?

  • Trade payables
  • Overdraft
• A current ratio of 1.5-2.5 would suggest what?

  Acceptable liquidity and efficient management of working captial
• What does a low current ratio (e.g. well below 1) indicate?

  Possible liquidity problems
• Why can a really high current ratio be bad?

  There could be too much capital invested in inventories and too many customers on receivables
• What does the current ratio depend on if the figure is good?

  • The industry or market that the business operates in
  • The trend of the ratio figure
• How does the industry or the market the business operates in suggest if the current ratio is a good figure?

  • Firms have different requirements of holding inventories (e.g. manufactures have high inventories)
  • How the business approaches trade credit and debt
  • How the ratio compare with competitors?
• How does the trend of the current ratio suggest if the current ratio is a good figure?

  A sudden deterioration in current ratio is a good indicator of liquidity problems
• What does a current ratio measure?

  How liquid a business is
• Where can you find the figures for calculating a current ratio?

  Balance sheet
• What is the best range for a current ratio?

  1.5 - 2.5
• What does a current ratio of below 1 suggest?

  The business is unable to cover their current liabilties