| Company A | Company B | |
| Current Assets | $ 6000 | $ 3,000 |
| Current Liabilities | $ 2000 | $ 1,500 |
| Working Capital | $ 4,000 | $ 1,500 |
| Current Ration | 3.0 | 2.0 |
From the example one can easily say that Company A is a winner in liquidity race on basis of more current assets and working capital but here are few things to notice which contradict the Company A winner statement. Let say, Company A and Company B have 30 days to pay their liabilities.
What If,
• Company A requires 8 months to collect account receivable whereas company B gets money back within a month.
• Company A inventory turnover is 2 times in a year on the other hand Company B inventory turnover is 12 times in a year.
The above mentioned cases clearly state that Company A cannot meet its liabilities obligation on time because current assets taking too much time to convert into cash. Despite of company B lower ratio it is the winner due to least time required to convert current assets into cash and pay liabilities within specified period of time.
Managers should use current ratio for liquidity analysis of the company but should consider the other attributes as discussed in this tutorial.
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Very nice post!
The comments on liquidity ratio is enough to understand this concept. pretty good.
We always believe to make things simple.