2- Liquidity ratio, the current ratio is most important for liquidity ratios

Current ratio

This ratio is the liquidity ratio that measures a company’s ability to pay off short-term liability or those due within one year. In other words, we can say that in the current ratio, we compare the current assets with the current liability to determine whether the company is capable of paying its short term liability.

Formula

The current ratio is the ratio of current assets and current liability

Current ratio = Current assets/ Current liability

If you do not know about the current assets and current liability, then you can read the post containing part 1 of the liquidity ratio, whose link we have given, please read now

You can find the data of current assets and current liability on balance sheet of any Indian company on the website https://www.moneycontrol.com/

Calculator example

1– If you are considering Company XYZ as a potential investment, one of the many pieces of information you examine is the liquidity position of the company.

When you check the balance sheet of Company XYZ, it can look like this:

  • Account receivable = 80000
  • Inventory = 20000
  • Stock holding or market securities = 50000
  • Cash = 50000
  • Current liabilities = 220000

Current assets = Account receivable + Inventory + Market securities + Cash

Hence current assets = 80000 + 20000 + 50000 + 50000 = 200000

When we plug the relevant data into the above formula, we get the this ratio of the XYZ company.

Current ratio of XYZ company = (current asset of XYZ company) / (current liability of XYZ company)

Current ratio = 200000 / 220000 = 0.9090

2. We take an an live example of BHEL (Bharat Heavy Electricals Ltd.) date- 20/07/2020

First of all, you have to go to the https://www.moneycotrol.com website, after that you will have to search by entering the name of the company and you will have to click on the option of financial data upwards. you will get an option of a balance sheet as soon as you click. On which you can find current assets and current liability by clicking.

I have found BHEL’s current assets and current liabilities data which you can see below

  • Current assets = 32711.18
  • Current liabilities = 22676.84

Current ratio of BHEL = current assets (32711.18) / current liabilities (22676.84) = 1.44

Analysis-

current ratio analysis

1- If the ratio is less than 1 – If the current ratio of a company is less than 1, then that company should avoid because it means that even if this company sells its current asset, it cannot get its short term liability.

  • short term troubles for a company
  • High liquidity ratio
  • May have to rais additional fanancing

2- If the ratio is more than 1 but not more than 1.45– When the current ratio of a company is above 1 and below 1.45, then we can monitor it with investment purpose

3. If the ratio is between 1.45 and 2.5– When the current ratio of a company is between 1.45 and 2.5, the company is considered to be in very good condition. Companies of this type indicate to invest money

It is not at all like that for a company whose current ratio is above 1.45, we should invest in that company. To invest in a company, we have to check a lot of factories.

4.When this ratio is more than 2.5– When the current ratio of a company is above 2.5, it is not considered to be in a good condition because it means that the company has more cash and the company is not doing its utilities properly.

Remark

On the top side, we have found the current ratio of the XYZ company and BHEL, now we analyze both the companies.

  • XYZ company’s current ratio (0.9090) is less than 1, which is not a good sign for a company. This means that the company’s current liabilities are higher than the company’s current assets, we should stay away from such companies
  • BHEL’s current ratio is around 1.45 which is a good sign for a company and we must keep a watch to invest in companies of this type.

In the next post we will talk about the Quick ratio

Thanks for reading our post, God bless you all

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