What is Current Ratio?
Identifying the ability of a company to clear off its short-term liabilities, current ratio is all about transforming assets into cash for paying off loans. Being a part of the financial analysis process of an organization, it works towards highlighting the company’s fiscal position. The current ratio is calculated as company’s current assets to its current liabilities. It is an important process undertaken by banks and financial institutions before providing loan to the companies for business purpose. Thereby, it is essential for the companies to portray a viable liquidity position of a company.
At times, there is a possibility that current ratio of a company might not be in a favorable position. This mandates for an improvisation, which can be done by sweeping bank accounts, clear off existing liabilities, sell unproductive assets, and even improve current assets by raising shareholders’ funds. Now, this makes it clear to the fact that such measures can add to the betterment of current ratio and clear you path in getting essential loans. It is quite evident that every bank will analyze a company’s to pay off its loans, before lending any amount. This is done out of security measures; so that the amount lent to the company might not stuck at the time of payment.
What is Current Ratio Formula?
Current Ratio can be calculated by dividing Current assets of the company by Current liabilities of the company we are calculating for.
Calculation Of Current Ratio
Suppose a company’s current assets stands at $100,000 and liabilities stands at $75,000 what would be current ratio of the company?
By implementing current ratio formula:
Current ratio = $100,000/ $75,000 = 1.333
Advantages of Current Ratio:
- It highlights the fact as to how a company is cash rich and holds the ability to pay off existing liabilities. A higher ratio confirms the stability of a company and a lower one brings the risk of liquidity associated with it.
- It provides an insight into the functional cycle of a company by emphasizing the ability of a company to transform its inventory into cash. This empowers them to plan out optimization of overhead costs and plan out inventory storage mechanisms.
- It brings out the fact as to how management of a company is efficient in handling creditor’s demands by making effective use of company’s working capital.
Every company in the business requires raising funds from the market in the form of loans. And current ratio tends to highlights its repayment capability to manage expenses. Certainly, this is not the only factor considered by banks in giving loan to a company. But, this does not mean that current ratio is not an important part of financial analysis. It has always helped companies and financial institutions in maintaining a cordial business relationship.