Current Ratio and Liquid Ratio
Chapter Twenty-Eight
Syllabus topic 2, "Balance Sheet Ratios : i) Current Ratio ii) Liquid Ratio iii) Stock Working Capital Ratio iv) Proprietary Ratio v) Debt Equity Ratio vi) Capital Gearing Ratio"
Pages 75 to 77 of 162
The current ratio
Current ratio = Current assets / Current liabilities
Expressed as "x to 1". The conventional standard is 2 to 1.
What it measures: whether the assets that will turn into cash within a year are enough to meet the liabilities that fall due within a year.
What is a current asset
| In | Out |
|---|---|
| Stock, of every kind | Fixed assets |
| Debtors and bills receivable | Long-term investments |
| Cash and bank balances | Fictitious assets: preliminary expenses, discount on issue |
| Prepaid expenses | A debt due after twelve months and outside the operating cycle |
| Short-term or marketable investments | |
| Accrued income |
What is a current liability
| In | Out |
|---|---|
| Creditors and bills payable | Debentures and long-term loans |
| Outstanding expenses | Share capital and reserves |
| Bank overdraft repayable on demand | |
| Provision for taxation | |
| Proposed dividend, where the question treats it as a liability | |
| Current maturities of a long-term loan | |
| Income received in advance |
Two of these are contested and a question will usually tell you. Provision for taxation is a current liability in the conventional treatment. Proposed dividend is not recognised as a liability under Schedule III, and a question that gives it as a separate figure usually intends it to be included; say which you have done.
Worked on Sunrise
| 2026, Rs | 2027, Rs | |
|---|---|---|
| Stock | 2,60,000 | 3,00,000 |
| Debtors | 1,60,000 | 2,40,000 |
| Cash and bank | 1,50,000 | 1,80,000 |
| Prepaid expenses | 20,000 | 40,000 |
| Current assets | 5,90,000 | 7,60,000 |
| 2026, Rs | 2027, Rs | |
|---|---|---|
| Creditors | 1,40,000 | 2,20,000 |
| Outstanding expenses | 32,000 | 38,000 |
| Provision for taxation | 78,000 | 1,02,000 |
| Current liabilities | 2,50,000 | 3,60,000 |
| 2026 | 2027 | |
|---|---|---|
| Current ratio | 2.36 to 1 | 2.11 to 1 |
Interpretation
Both years are above the conventional 2 to 1, so short-term solvency is comfortable in each. But the direction is downward, from 2.36 to 2.11, because current liabilities grew 44 per cent against current assets at 28.81 per cent.
Say both things. The level is satisfactory and the trend is adverse, and a company whose ratio has fallen a quarter of a point in one year will fall below 2 in about two more if nothing changes.
Reading a figure
| Current ratio | Usually means |
|---|---|
| Well below 2 to 1 | The business may struggle to pay within the year; a banker will look hard |
| About 2 to 1 | Conventionally satisfactory |
| Well above 2 to 1 | Not a compliment. Cash, stock or debtors are lying idle when they could be earning; or stock is unsaleable, or debtors uncollectable |
The last row is the mark most students miss. A very high current ratio is a criticism, and saying so is what distinguishes an interpretation from a verification.
The liquid ratio
Also called the quick ratio or the acid test ratio. All three names are the same ratio and MU may use any of them.
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