Question

Imagine that you’ve been asked to explain one of the major accounting ratios to a group of high school students who have no background in business or accounting, but who are eager to learn. Choose one of the following ratios and describe how you would explain it in your own words, using a specific example: current ratio, asset turnover, or profit margin on sales.

Answer 1

Current Ratio:   

Current Ratio is the comparison of a company's current assets to its current liabilities.

Let me take a illustration-

There is a young boy Ram who is willing to start a Fruit Shop. Ram don't have any cash. He purchase Fruit of Rs. 50000 on credit from his friend. He sold the fruit for Rs. 60000/- in cash.

In the present case Ram Current Assets is Rs. 60000/- . By this we understand that

A current asset is either cash, a cash equivalent, or which can be converted into cash within one year.

Ram Owes Rs. 50000/- to his friend. This is Ram Current Liability. By this we understand that-

A current liability is an obligation that is payable within one year.

Ram Current Ratio will be-

Current Assets / Current Liabilities i.e. 60000/50000 =  1.2 times