M.COM. SEMESTER – II (CBCS)

CORPORATE FINANCE 

Q.9.
explain current ratio and advantages

ANS:

This ratio measures
the solvency of the company in the short-term; current assets are those assets
which can be converted into cash within a year. Current liabilities and
provisions are those liabilities that are payable within a year.   

                                           Current Assets, Loans & Advances

                                             Current Liabilities & Provisions

A current
ratio of 2:1 indicates a highly solvent position A current ratio of 1.33: 1 is
considered by banks as the minimum acceptable level for providing working
capital finance. The constituents of the current assets are as important as the
current assets themselves for evaluation of a company’s solvency position. A
very high current ratio will have adverse impact on the profitability of the
organization. A high current ratio may be due to the piling up of inventory,
inefficiency in collection of debtors, high balances in cash and bank accounts
without proper investment etc.

Advantages
of Current Ratio

1. This
ratio indicates the extent of current asset available to meet the current
obligations. It is only from the current assets the immediate obligations
(current liabilities) are met with. Therefore, the interest of creditors lies
in this ratio.

2. The safe
ratio is 2:1. This means, for every current liability of Rs. 1, there should be
current assets of Rs. 2, so that the firm can conveniently meet its current
obligations, even if the assets like stock or debtors are not quickly realized.

3. This
margin also leaves sufficient amount as working capital to carry out day-to-day
transactions.

4. This is useful
in assessing the solvency and liquidity position of the company.

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