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<tbody>
<tr>
<td width="130" valign="top"><strong> </strong></td>
<td width="213" valign="top"><strong>Company A</strong></td>
<td width="213" valign="top"><strong>Company B</strong></td>
</tr>
<tr>
<td width="130" valign="top">Current Assets</td>
<td width="213" valign="top">$ 6000</td>
<td width="213" valign="top">$ 3,000</td>
</tr>
<tr>
<td width="130" valign="top">Current Liabilities</td>
<td width="213" valign="top">$ 2000</td>
<td width="213" valign="top">$ 1,500</td>
</tr>
<tr>
<td width="130" valign="top">Working Capital</td>
<td width="213" valign="top">$ 4,000</td>
<td width="213" valign="top">$ 1,500</td>
</tr>
<tr>
<td width="130" valign="top"> </td>
<td width="213" valign="top"> </td>
<td width="213" valign="top"> </td>
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<tr>
<td width="130" valign="top">Current Ration</td>
<td width="213" valign="top">3.0</td>
<td width="213" valign="top">2.0</td>
</tr>
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<p align="justify">
<p align="justify">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.</p>
<p align="justify">What If,<br />
• Company A requires 8 months to collect account receivable whereas company B gets money back within a month.</p>
<p align="justify">• Company A inventory turnover is 2 times in a year on the other hand Company B inventory turnover is 12 times in a year.</p>
<p align="justify">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.<br />
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.