Current Ratio

Current Ratio

Current Ratio:

The current ratio is a ratio between current assets and current liabilities of a business enterprise.
The current ratio establishes a relationship between current assets and current liabilities of a firm for a particular period.
Current Ratio is a liquidity ratio that measures ability of the business enterprise to pay its short-term financial obligations.

It compares the current assets and current liabilities of the firm.
The Current ratio is also known as the working capital ratio.

Significance of Current Ratio:

The objective of computing this ratio is to measure the ability of the firm to meet its short-term liability.

It indicates the amount of current assets available for repayment of current liabilities.
The higher the ratio, the greater is the short-term solvency of a firm and vice – versa.

The acceptable current ratio differs from business to business depending upon the risk involved.

Thus, the ideal current ratio of a company is 2 : 1 .
A current ratio below 1 means that the company doesn’t have enough liquid assets to cover its short-term liabilities.

Current Assets:

Current Assets are those assets that are held for short period and can be converted into cash within one year. The balance of such items goes on fluctuating i.e. it keeps on changing throughout the year. It includes the following :
Cash in hand,
Cash at Bank,
Trade Receivables,
Short term investment,
Inventories,
Prepaid expenses.
Trade Receivables include Bills Receivables and Sundry Debtors.

Note- Inventories (excluding Loose Tools and Spare Parts)

Current Liabilities:

Current Liabilities are obligations or debts that are payable within a period of one-year . It includes the following:
Trade Payables,
Bank overdraft,
Provision for tax,
Outstanding expenses,
Cash Credit
Short-term borrowings.

Trade Payables include Sundry Creditors and Bills Payables.

Formula for the Current ratio:

 

Current Assets = Current Investments + Inventories (Excluding Spare Parts and Loose Tools) + Trade Receivables + Cash and Cash Equivalents +Short Term Loans and Advances + Other Current Assets.

Current Liabilities= Short-Term Borrowings +Trade Payables +Other Current Liabilities+ Short-term Provisions+Cash Credit.

(Standard Current Ratio:- 2:1)
Illustrations For Current Ratio:

Illustration 1.

Calculate current ratio from the following :    

Current Assets  ₹10,00,000
Current Liabilities ₹ 4,00,000

Solution:

Current ratio=10,00,000/4,00,000

Current Ratio= 2.5:1

Illustration 2.

Calculate current ratio from the following :    

Sundry debtors  ₹4,00,000
Inventories ₹1,60,000
Marketable securities ₹ 80,000
Cash ₹1,20,000
Prepaid expenses ₹40,000
Bills payables ₹ 80,000
Sundry creditors ₹2,60,000
10%Debentures ₹ 5,00,000
Outstanding Expenses ₹  60,000

Solution:

Current Assets =Sundry debtors  +Inventories+Marketable securities +Cash +
Prepaid expenses 

Current Assets = 4,00,000+1,60,000+80,000+1,20,000+40,000

Current Assets = 8,00,000

Current Liabilities=Bills payables +Sundry creditors +Outstanding Expenses 

Current Liabilities=80,000 +2,60,000 +60,000

Current Liabilities=4,00,000

current ratio=8,00,000/4,00,000

Current Ratio= 2:1

Illustration 3.

Calculate current ratio from the following :    

Non-Current Tangible Assets ₹9,00,000
Non-Current Intangible Assets ₹3,00,000
Share Capital ₹9,00,000
Sundry debtors  ₹3,40,000
Inventories ₹2,00,000
Current Investment ₹ 1,40,000
Cash in hand ₹80,000
Cashat Bank ₹20,000
Accrued Income ₹20,000
Prepaid expenses ₹40,000
Bills payables ₹ 80,000
Sundry creditors ₹2,20,000
Bank Overdraft ₹80,000
10%Debentures(First) ₹ 5,00,000
9%Debentures(Second) ₹ 2,00,000
Outstanding Expenses ₹  10,000
Provision for Taxation ₹  30,000
Solution:

Current Assets =Sundry debtors  +Inventories+Current Investment+ Accrued Income + Cash in hand + Cash at Bank+Prepaid expenses 

Current Assets = 3,40,000+2,00,000+1,40,000+20,000+80,000+20,000+40,000

Current Assets = 8,40,000

Current Liabilities=Bills payables +Sundry creditors+Bank Overdraft +Outstanding Expenses +Provision for Taxation

Current Liabilities=80,000 +2,20,000 +80,000+10,000+30,000

Current Liabilities=4,20,000

Current ratio=8,40,000/4,20,000

Current Ratio= 2:1

Illustration 4.

Calculate current ratio from the following :    

Total Assets ₹9,00,000
Non-Current Assets ₹6,00,000
Shareholders Fund ₹5,00,000
Non-Current Liabilities  ₹2,50,000

Solution:

Total Assets=Non Current Assets+Current Assets
₹9,00,000=₹6,00,000+Current Assets
Current Assets= 9,00,000-6,00,000= 3,00,000
Total Assets=Tatal Liabilities
Total Liabilities= Shareholders Fund +Non-Current Liabilities +Current Liabilities
9,00,000= 5,00,000+2,50,000+Current Liabilities
Current Liabilities= 9,00,000-7,50,000
Current Liabilities=1,50,000

Current ratio=3,00,000/1,50,000

Current ratio=2:1

Illustration 5.

Calculate current ratio from the following :    

Total Assets ₹9,00,000
Non-Current Investment ₹3,00,000
Fixed Assets ₹4,00,000
Shareholders Fund ₹5,00,000
Non-Current Liabilities  ₹2,50,000

Solution:

Total Assets=Non Current Assets+Non current Investment+Current Assets
₹9,00,000=₹4,00,000+₹3,00,000Current Assets
Current Assets= 9,00,000-7,00,000= 2,00,000
Total Assets=Tatal Liabilities
Total Liabilities= Shareholders Fund +Non-Current Liabilities +Current Liabilities
9,00,000= 5,00,000+2,50,000+Current Liabilities
Current Liabilities= 9,00,000-7,50,000
Current Liabilities=1,50,000

Current ratio=2,00,000/1,50,000

Current ratio=1.33:1

Illustration 6.

Calculate current ratio from the following :    

Working capital ₹3,00,000
Current Assets ₹5,00,000

Solution:

Working capital = Current Assets – Current Liabilities
₹3,00,000= ₹5,00,000 – Current Liabilities
Current Liabilities=₹5,00,000- ₹3,00,000

Current Liabilities=₹2,00,000

Current ratio=3,00,000/2,00,000

Current ratio=1.5:1

Illustration 7.

Calculate current ratio from the following :    

Working capital ₹3,00,000
Current Liabilities ₹2,00,000

Solution:

Working capital = Current Assets – Current Liabilities
₹3,00,000= Current Assets – ₹2,00,000
Current Assets =₹3,00,000+ ₹2,00,000

Current Assets =₹5,00,000

Current ratio=5,00,000/2,00,000

Current ratio=2.5:1

Interest Coverage Ratio

Debtors Turnover Ratio(Trade Receivable Turnover Ratio)

 

 

 

 

 

 

 

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