Current Ratio-Class 12 Accounts (Accounting ratios)NCERT,ICSE Class 9,HSC/Std-XIIth Video Lecture

What are current assets?
Current assets are short term assets.
They remain in the business for a very short
period of time, generally not more than one
year.
For ex debtors.
Generally we receive the amount recievable
from the debtors within one year.
No business allows a credit period of one
year.
Generally, the credit period given to
debtors is 90 to 120 days.
At max, it could be six months.
What are current liabilities ?
Current liabilities like current assets are
also short term liabilities
They are to be repaid generally within
a year.
For example, Creditors.
The rule that applies to debtors also applies
to creditors.
No business can afford to give a credit period
of more than one year.
What is a current ratio?
Current ratio is a ratio that helps us to
analyse the short term liquidity position
of a company.
The formula for calculating the current ratio
is current assets
divided by current liabilities.
It ia also called as a working capital ratio.
How do we interpret the current ratio?
The standard current ratio is 2:1.
When we say current ratio is 2:1, it means
that current assets of the firm are twice
that of current liabilities.
It means that if the current liabilities are
Rs.100
then the current assets of the company are
Rs.200.
It means that the company has a very comfortable
position of working capital.
It means that creditors shoudnt worry about
getting their payments from the company on
time.
It also means that the company is unlikely
to face any liquidity crunch or cash crunch
if you consider a time frame of next one year.
This is very good sign for any company.
However, if the current ratio is less than
2:1,
it may start creating doubts in the minds
of suppliers.
So its always advisable for any company to
maintain a current ratio of around 2:1 or
may be slightly higher.
On the flip side, the company shouldnt have
a very high current ratio also.
Please remember cash is a part of current
assets.
Generally a high current ratio happens when
the company has excess cash or it could be
due to the fact that the company may be giving
excess credit or excess credit period
to its customers or debtors.
If you are giving too much credit to your
debtors or the customers, it is likely that
you may face a financial problem in long term.
On the other hand, having too much cash us
also not a very good situation.
Idle cash does not give any return to the
company.
If the company has excess cash the company
should utilise it for the expansion of business
or it should invest it somewhere so that it
can earn some good returns on the investment.
Having too much cash is a good sign from the
creditors perspective.
However from the company's perspective it
is not a good sign.
It indicates that the company is not making
productive use of the excess cash that it
is holding