Current Ratio Definition - Formula - Importance - Example

Current Ratio defines the relationship between Current Assets And Current Liabilities. The company is strong enough to maintain its Working Capital effective, if this ratio is equal to 1 or more. But, if it is less than 1 or negative then it shows that the company can’t not pay the due amount to Creditors and not suitable for investors.

  

Current Ratio is also called Liquidity ratio because it shows those current assets of the business which can be converted into cash within the year and these Current Assets are used to meet daily working expenses of the business. 

  

Current Ratio Formula And Calculation

  

It is the ratio of Current Assets To Current Liabilities and it is written in mathematical form as: 

  

Current Ratio = Current Assets / Current Liabilities 

  

Importance of Current Ratio 

  

1. By knowing the Current Ratio or Working Capital Ratio or Liquidity Ratio of a company, an investor or Account Receivable and other financial institutions, including Banks, etc., are interested in investing and giving Loans to that particular company.

  

2. This ratio also shows that the company is performing well in meeting its short-term obligations and pay their dues in time. 

  

3. The Company is more efficient in Working Capital Management Decisions.

  

Example: 

  

If Current Assets of Company From The Balance Sheet or Statement of Financial Position is Rs. 70000 and Current Liabilities is Rs. 40000, Then, Current Ratio is given below: 

  

                                                                70000 / 40000 = 1.75  

So, this is a good Current Ratio for the company as it is more than 1 and if it is equal to 1, then it is ideal situation for the company but it depends upon the nature of the business and the types of industry in which a business is running. For Some businesses, it is ideal and for some business it is not ideal. It all depends upon the nature of the business and current business and market situations.

  

So, Current Assets/Current Liabilities is called Current Ratio and it shows the strengths of the company in paying off its short-term obligations, so investors are interested in making investment and creditors give credit to that particular company.