Question

The higher the company's current ratio, the better the company's financial condition. Do you agree or disagree with this statement and why? Include in your response, what the current ratio is measuring and why it is the most widely used ratio in analyzing financial statements.

Answer 1

Answer The current ratio is a liquidity ratio that measures a company's ability to pay short- term obligations or those due within one year. It tells investors and analysts how a company can maximize the current assets on its balance sheet to satisfy its current debt and other payables. To calculate the ratio, analysts compare a company's current assets to its current liabilities. Current assets listed on a company's balance sheet include cash, accounts receivable, inventory and other assets that are expected to be liquidated or turned into cash in less than one year. Current liabilities include accounts payable, wages, taxes payable, and the current portion of long-term debt. I both Agree and Disagree with the statement of The higher the company's current ratio, the better the company's financial condition. Reason to Agree 1) a current ratio greater than one indicates the company has the financial resources to remain solvent in the short-term. 2) the higher the current ratio, the more capable a company is of paying its obligations because it has a larger proportion of short-term asset value relative to the value of its short-term liabilities. Reasons to Disagree 1) a company may have a very high current ratio, but its accounts receivable may be very aged, perhaps because its customers pay very slowly, which may be hidden in the current ratio. 2) Analysts must also consider the quality of a company's other assets versus its obligations as well. If the inventory is unable to be sold, the current ratio may still look acceptable at one point in time, but the company may be headed for default. 3) The cash or bank balances may belying idle. Importance of Current Ratio We can determine the short term liquidity of a business concern using the Current ratio. An increase in the current ratio represents improvement in the liquidity position of a business concern and wisc versa. As a banker's rule of thumb, the standard for current ratio is 2:1. It helps investors understand more about a company's ability to cover its short-term debt with its current assets.