Current Ratio Measuring Liquidity

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Definition: Current Ratio Measuring Liquidity

An important technique to measure the liquidity of a firm is analyzing its current ratio. It shows the ability of the firm to clear its obligations in the short term. The higher the current ratio, the better its ability to clear its short term liabilities.

Current ratio is also known as working capital ratio and is denoted by-

Current Assets/Current Liabilities.

Generally a current ratio of 2 or more than 2 for most of the industries shows a good liquidity.

But this technique may not always show a true measure of liquidity as it ignores the effect of time. A company may have huge current assets and current liabilities but may hold the current assets and use them to clear the liabilities only after a certain time. This company will have a high current ratio but basically has poor liquidity which can use its current assets immediately to clear its bills.

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