The Current Ratio Essay

1474 Words Sep 24th, 2016 6 Pages
The aim of the Current Ratio is to assess an entity’s ability to meet its short term liabilities. The ratio shows the number of times current assets can be converted into cash to meet the current liabilities of an entity (Accounting Explained n.d.). When reviewing the Current Ratio it is a subjective guide that it should be around $1.5 of current assets for every dollar of current liabilities. A low ratio indicates an entity may have difficulty in meeting its current liabilities or not enough working capital. A high ratio is a sign of inefficient use of funds. In this instance Trust PTY LTD has seen an increase in the current ratio from year to year, this could indicate a more conservative approach being taken to capital management or improved liquidity. In this example the net profit margin has increased indicating efficient use of the entities funds.

Ideally an entity will have a quick ratio that covers itself against liquidity risk (Accounting Explained n.d.). In general terms the higher the risk within an industry the entities within this sector will have a higher quick ratio. In contrast it may also carry a lower quick ratio due to better credit terms. Analysis over a number of reporting periods may also show seasonal impacts within certain industries providing context on short term increases or decreases in the ratio. In this example the ratio increased year over year. In this instance it may choose to reinvest the funds or provide returns to shareholders.

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