Examples of Companies With High and Low Current Ratios

Introduction

The current ratio is one of the most common measures of financial health for a business. It is defined as the ratio of current assets to current liabilities and is used to measure the ability of a company to pay its immediate obligations through its available assets. It helps investors to measure the liquidity of a company and identify its potential for meeting future monetary demands.

When examining the current ratio, companies may be classified as either having a high or low ratio, depending on the industry and nature of their operations. In this blog post, we will discuss some examples of companies with both high and low current ratios as well as the factors that contribute to a high or low ratio.

High Current Ratios

A company's current ratio is a key metric that reflects a company's financial health.

In general, a high current ratio indicates a company is in good financial condition, which is an attractive quality for potential investors and creditors. A high current ratio means a company has ample cash and liquid assets to cover its short-term debt obligations, and that the business is generating a steady stream of earnings.

Here are some examples of companies that have high current ratios:

• Apple Inc. had a current ratio of 3.19 as of December 2019.
• Johnson & Johnson had a current ratio of 2.12 as of December 2019.
• Walmart had a current ratio of 1.88 as of December 2019.
• Microsoft had a current ratio of 2.25 as of December 2019.

Reasons for a High Current Ratio

The underlying reasons for a high current ratio can vary, but it typically indicates that a company has a strong cash position. In particular, a company may have abundant access to short-term financing, steady cash flow from operations, or fewer current liabilities than previously anticipated.

Another possible explanation is that a company is holding onto excessive cash and other liquid assets. Excess liquidity can hurt a company's bottom line, as the cash that isn't being reinvested into the business is not generating a return. Investors should be wary of companies with consistently high current ratios as it could be a sign of inefficient capital management.

Low Current Ratios

Example of Companies with Low Current Ratio

The current ratio measures a company's ability to meet its short-term obligations and provides insight into potential financial problems. A current ratio that is too low could indicate that a company may have difficulty paying its bills in the short term. Some common examples of companies with low current ratios include:

• Retail stores—Retail stores often require significant amounts of inventory and other current assets to meet customer demand and generate revenue. Consequently, their current ratio is typically lower than other industries.
• Small businesses—Small businesses often lack the capital to invest in large amounts of current assets. This lack of capital leads to lower current ratios.
• Utilities—Utilities companies often use long-term debt to finance their large capital investments for utilities such as power plants and pipelines. As a result, their current ratio is often much lower compared to other industries.
• High-tech companies—High-tech companies often have very little in the way of current assets because they are highly dependent on intangible assets such as software and patents. These intangible assets are not typically converted into cash in the short term, resulting in lower current ratios.

Reasons for a Low Current Ratio

There are several reasons why a company may have a lower current ratio. These include:

• Excess inventory—Excess inventory can be a sign of a poor inventory management system or over-investment in inventory. This can reduce a company's current ratio as inventory does not typically convert to cash in the short term.
• Too much debt—Having too much debt can reduce a company's current ratio as long-term debt is usually not due for several years and cannot be used to pay liabilities in the short term.
• High accounts receivable—High accounts receivable can be indicative of lax payment terms or difficulty collecting payments from customers. This can reduce a company's current ratio.
• Insufficient cash—A lack of adequate cash can reduce a company's current ratio as cash is the most liquid asset and is therefore critical for current liabilities.

Gaining Insight From the Current Ratios

Gaining insights into company performance can be done by analyzing their current ratios. The current ratio measures a company’s ability to pay its short-term obligations, such as accounts payable and short-term loans. A high current ratio, usually over 2, means that the company is likely to have more short-term assets than short-term liabilities, while a lower ratio indicates that the company may be unable to pay its current bills.

Analyzing current ratios of different companies

It is important to look at the current ratios of individual companies to get an understanding of their short-term liquidity. A high current ratio should be followed up with further analysis of the company’s balance sheet to make sure that the high current ratio is a result of good financial management or one-off factors such as high levels of inventory. Similarly, a low current ratio should be dug into further to make sure the company will be able to meet its short-term obligations.

Identifying industry trends

Analyzing the current ratios of various companies can also help analysts identify industry trends. For example, if a particular sector of the economy is well known for having high current ratios, it can be useful to see which companies have higher or lower current ratios than the sector’s average. Analyzing which companies have improved or deteriorated ratios can help investors make informed decisions about where to invest their money.

• Analyzing the current ratios of different companies can help investors understand the short-term liquidity of an organization.
• It is also beneficial to identify industry trends to spot anomalies and make better investment decisions.

Advantages of High and Low Current Ratios

The current ratio, also known as the working capital ratio, measures a company’s ability to pay off current debts and obligations. A company’s current ratio is calculated by comparing its total current assets to its total current liabilities. Companies can have different current ratios depending on their business operations and financial positions. This article will explore the advantages of having a high and low current ratio as examples.

Advantages of a High Current Ratio

Having a high current ratio indicates that a company has enough liquid assets to pay off current debts and obligations. Generally speaking, a current ratio of 2:1 or higher indicates that a company is able to cover any unexpected current liabilities. This can provide investors with a sense of security and make the company more attractive to potential lenders. Additionally, a high current ratio is a good indication of overall financial health, as it shows that the company is maintaining a good balance between short-term assets and liabilities.

Advantages of a Low Current Ratio

Though having a high current ratio can be beneficial, it may indicate that a company is not utilizing its resources efficiently. A lower current ratio shows that a company has few liquid assets and is investing heavily in long-term assets. This can be beneficial for businesses that rely on long-term investments to remain profitable, as it shows that the company is not holding onto excess cash. Additionally, a lower current ratio may reflect a company’s dedication to managing its cash flow, as it is only investing in assets that provide the highest return on investment.

Disadvantages of High and Low Current Ratios

Disadvantages of a High Current Ratio

Having a high current ratio can result in a few negative aspects. First, by having an abundance of non-earning and normally unfavorable current assets, such as cash, debtors, and inventories, companies run the risk of unproductively deploying and investing those assets, damaging their income and profitability instead of adding positive returns. Secondly, a high current ratio can signal investors that the company holds too much cash in its reserves, being either unprepared for any possible financial difficulties or unable to identify and implement effective investments.

Thirdly, if a company seems to be able to cover all its current liabilities with no cash left over, it can be indicative of an overcapitalized organisation, which will, in the best case, generate a detrimental environment for the management. Finally, a high current ratio can decrease the liquidity of a company, preventing it from taking advantage of opportunities to purchase other companies, consolidate subsidiaries and maximize revenue when possible.

Disadvantages of a Low Current Ratio

Having a low current ratio can also result in a few negative assumptions and outcomes. First, when a company has a low current ratio, investors are generally pessimistic as it implies, on one hand, a lack of cash to pay any short-term debts, and, on the other, a possible lack of interest or knowledge over the proper use of assets, leading to inefficient or inappropriate decision-making. Secondly, risk levels can be perceived as significantly higher due to the fact that a company with a low current ratio might not be financially sound.

Thirdly, a cash-pressured business with a low current ratio carries a higher risk for financial distress, compared to its more solvent competitors, thus, leading to higher costs of capital. Lastly, a business with a low current ratio can have difficulty keeping up with the competition due to its restricted access to new markets or investments opportunities.

Conclusion

High and low current ratios can provide useful insight into the financial health of a business. A high current ratio indicates that the company is able to meet its short-term financial obligations. A low current ratio indicates that the company may not have enough liquid assets to meet its current liabilities. Both ratios can give investors and creditors an indication of the company’s financial health, allowing them to make better decisions when making investments or extending credit.

It is important to examine the current ratio in terms of the industry and the company’s specific circumstances. Different industries may have higher or lower current ratios based on the products and services they provide, their ability to generate income, and their financial obligations. Ultimately, the strength of the current ratio can provide insight into the financial standing of a company.