Likewise, Disney has a 81 cents in current assets for each dollar of current debt. Apple has more than enough to cover its current liabilities if they come due. As such, when using them it is important to understand their limitations, and the same holds true for the current ratio.
One limitation of using the current ratio emerges when using the ratio to compare different companies with one another. Because business operations can differ substantially between industries, comparing the current ratios of companies in different industries with one another will not necessarily lead to any productive insight.
For example, while in one industry it may be common practice to take on a large amount of debt through leverageanother industry may strive to keep debts to a minimum and pay them off as soon as possible.
Companies within these two industries, then, could potentially have very different current ratios, though this would not necessarily indicate that one is healthier than the other because of their differing business practices.
As such, it is always more useful to compare companies within the same industry.
Another drawback of using current ratios, briefly mentioned above, involves its lack of specificity. Of all of the different liquidity ratios that exist, the current ratio is one of the least stringent. As such, a high current ratio cannot be used to effectively determine if a company is inefficiently deploying its assets, whereas certain other liquidity ratios can.
However, there are a variety of different liquidity ratios that exist and that measure this in different ways.
When considering the current ratio, it is important to understand its relationship to other popular liquidity ratios. Another class of liquidity ratios works in a similar way to the current ratio, but is more specific as to the kinds of assets it incorporates.
The operating cash flow ratio compares a companies active cash flow from operations to its current liabilities.
Another similar liquidity ratio is the debt ratiowhich is the opposite of the current ratio.The current ratio is the ratio of current assets to current liabilities.
How it works (Example): The current ratio is a commonly used liquidity ratio that measures a company's ability to pay its current liabilities with its current assets.
The quick ratio or acid test ratio is a liquidity ratio that measures the ability of a company to pay its current liabilities when they come due with only quick assets. Quick assets are current assets that can be converted to cash within 90 days or in the short-term.
Current Ratio is calculated as Current Assets of Colgate divided by Current Liability of Colgate. For example, in , Current Assets was $4, million and Current Liability was $3, million.
Interpretation & Analysis. Current ratio is a measure of liquidity of a company at a certain date. It must be analyzed in the context of the industry the company primarily relates to. The underlying trend of the ratio must also be monitored over a period of time.
Current ratio is one of the most fundamental liquidity ratio. It measures the ability of a business to repay current liabilities with current assets. Ratio Analysis of Financial Statements – This is the most comprehensive guide to Ratio Analysis / Financial Statement Analysis This expert-written guide goes beyond the usual gibberish and explore practical Financial Statement Analysis as used by Investment Bankers and Equity Research Analysts.