CURRENT RATIO Flashcards
What is liquidity
A measure of the ability of a firm to meet its short term debts.
What is the definition and formula of current ratio
Measures the ability of a firm to meet its short term debts (12 months or less is short term) by comparing current assets to current liabilities.
= current assets/ current liabilities
What is ‘inventories’
Total value of stock (raw materials, WIP, finished goods)
What are ‘recievables’
Money owed by debtors
What is ‘cash’
On premises or in the bank
What is ‘total current assets’
Will be turned into cash in nect 12 months, inventories + recievables + cash
WHat is ‘total current liabilities’
Money owed within the next 12 months
Understanding current ratio
1.5:1 is considered the ‘ideal’ amount. This means a firm has £1.50 for every £1 of debt to pay over the next year.
Any higher than this would indicate that the firm has too much money sitting around doing nothing. This money could be reinvested into profitable fixed assets or distributed to shareholders.
Any lower than that it may mean that a business may not be able to pay their debts over the next 12 months
How can you imporve current ratios that are too low
Increase available cash (sell shares, assets, borrow etc)
Reduce credit purchases, pay off debts
