Question

What financial information does the current ratio measure? How does the current ratio relate to other liquidity ratios? What financial ratios would you use to determine whether or not an organization meets its commercial bank loan payments? How?

Answer 1

Current ratio measures a company's ability to pay its current obligations using its current assets like cash or accounts receivables. It is one of the important criteria used by banks while lending money to organizations. In fact, many banks put current ratio limits on the loan covenants while issuing debt.

Other mostly used liquidity measure is quick ratio which excludes inventory from current assets before dividing it by current liabilities. This is done primarily because for few companies inventories are not much liquid and thus harder to convert into cash.

Cash ratio is the ability to pay current obligations using just the cash and equivalents. Better the cash ratio, better the position of the company.

These all ratios measure the liquidity of the company. Since nothing is better than cash, the more the cash, the better off is the company. Company's with highest cash ratios are really liquid as they can pay off any obligation with just the cash sitting in their accounts. Banks love these kinda companies.