On the basis of the following information, answer the question :

To measure the short term financial position __________ ratio can be calculated.

Current Ratio

The correct answer is Option (2) - Current Ratio.

To measure the short term financial position Current ratio can be calculated.

Current ratio is the proportion of current assets to current liabilities.
It is expressed as follows: Current Ratio = Current Assets : Current Liabilities.

Current assets include current investments, inventories, trade receivables (debtors and bills receivables), cash and cash equivalents, short-term loans and advances and other current assets such as prepaid expenses, advance tax and accrued income, etc. Current liabilities include short-term borrowings, trade payables (creditors and bills payables), other current liabilities and short-term provisions.

It provides a measure of degree to which current assets cover current liabilities. The excess of current assets over current liabilities provides a measure of safety margin available against uncertainty in realisation of current assets and flow of funds. The ratio should be reasonable. It should neither be very high or very low. Both the situations have their inherent disadvantages. A very high current ratio implies heavy investment in current assets which is not a good sign as it reflects under utilisation or improper utilisation of resources. A low ratio endangers the business and puts it at risk of facing a situation where it will not be able to pay its short-term debt on time. If this problem persists, it may affect firm’s credit worthiness adversely. Normally, it is safe to have this ratio within the range of 2:1.