Assume XYZ Corp. had a current ratio of 12.5 You are the CFO of XYZ Corp. Would

Question

Assume XYZ Corp. had a current ratio of 12.5 You are the CFO of XYZ Corp. Would you argue the high current ratio is good or bad? Why?

Ratios provide us with the ability to quickly assess a particular item. We can quickly assess short-term liquidity by looking at a firm's current ratio. We can quickly assess a firms capital structure by looking at a firm's debt to equity ratio. So ratios provide excellent and quick information. That said, why would relying on one ratio likely lead to an inaccurate conclusion about a particular company?

Explanation / Answer

Current ratio is a financial ratio that measures whether or not a company has enough resources to pay its debt over the next business cycle (usually 12 months) by comparing firm's current assets to its current liabilities.

As a CFO of XYZ. I would say current ratio is good because:-

Acceptable current ratio values vary from industry to industry. Generally, a current ratio of 2:1 is considered to be acceptable. The higher the current ratio is, the more capable the company is to pay its obligations. Current ratio is also affected by seasonality.

Current ratio gives an idea of company's operating efficiency. A high ratio indicates "safe" liquidity, but also it can be a signal that the company has problems getting paid on its receivable or have long inventory turnover, both symptoms that the company may not be efficiently using its current assets

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