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When the current liablities fall due, you should caculate whether the current assets meet short-term liablities or not. The current ratio measures the adequacy of current assets to meet short-term liabilities. The current ratio formula is:
Current ratio = Current assets/Current liabilities
Mostly, a current ratio of 2 or higher was regarded as appropriate for most businesses, but companies vary in their level of current ratio depending on the trade, and the current ratio should be looked at what is normal for the business. It’s meaningful in the similar business.
A higher figure is not too good because:
- high levels of inventory and receiables
- high cash levels which could be put to better use.
Some important information is often being forgot. We also should consider:
- availability of further finance
- seasonal nature of the business
- long-term liabilities and when they fall due and how they will be financed
- nature of inventory.
Here, there is another ratio to analyse the financial stability: the qucik ratio. The quick ratio formula is:
Quick raito = (Current assets – inventory) /Current liabilities
The quick ratio provide a better indicator of short-term liquidity.
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