Current Ratio is a calculated financial ratio that measures that will a company be able to fulfill its short term obligations in the next twelve months. In order to measure the ability of a company to pay its debt the current ratio compares the current liabilities of a company to its current assets. Current ratio is a liquidity ratio that is used to measure the financial strength of a company or a business. Current ratio is also named as liquidity ratio, cash ratio and cash asset ratio. In simple words we can say that current ratio is the measure of the company’s liquidity. The ratio is used to measure the financial position of a company over a specific period of time.
Current ratio can also be defined as the relationship between the current liabilities and current assets of the firm. This ratio is also called as the capital term ratio and is one of tools to measure the capital strength of a company. The two major components to calculate the current ratio are the assets and liabilities as it is the ratio of both these financial figures. The major objective of calculating the current ratio is to match current liabilities with the current assets to make that the firm will be able to settle down its liabilities with the current assets. As discussed above there are two major components of the current ratio the current assets and the current liabilities. Current assets consist of cash and every thing that can be converted into cash within a given period of time such as inventory, other investments, stocks and securities, various debtors and bills receivables of a firm. Prepaid expenses should also be the part of current assets not the current liabilities as because payment made in advance are not a burden on the company in near future.
On the other hand the current liabilities of a firm or company are the payable obligations of a firm that it must fulfill in the near future. Current liabilities include bill payable, various creditors, short term advances and loans, income tax payable, outstanding expenses payable, dividends and banks over drafts. In some cases the bank over draft is considered to be a long term liability and is subtracted from current liabilities. If the current assets of a company are more than twice as compared to the current liabilities the company is considered to be financially strong. If the current liabilities of a company have surpassed the current assets the company is considered to be financially unstable.