Microsoft has developed into the number two cloud computing company in the world behind Amazon.
BREAKING DOWN 'Current Ratio' A company with a current ratio less than one does not have the capital on hand to meet its short-term obligations if they were all due at once, while a current ratio greater than one indicates the company should be able to remain solvent in the short-term.
For example, a company may have a very high current ratio but their accounts receivable are low quality.
Perhaps they have not been able to collect from their customers quickly which may be hidden in the current ratio. If inventory is unable to be sold, the current ratio may still look acceptable, but the company may be headed for default. A current ratio that is less than one may seem alarming.
A current ratio less than one would not be concerning if the company has a much higher receivables turnover than payables turnover. For example, retail companies collect very quickly from consumers but have a long time to pay their suppliers.
Because of this imbalance, a current ratio below 1 is normal within the industry group. In theory, the higher the current ratio, the more capable the company is of paying its obligations because it has a larger proportion of short-term asset value relative to the value of its short-term liabilities.
However, a high ratio over 3 could indicate the company is not using its current assets efficiently, is not securing financing very well, or is not managing its working capital.
Apple had more than enough to cover its current liabilities if they were all theoretically due immediately and all current assets could be turned into cash.
Limitations of 'Current Ratio' One limitation of using the current ratio emerges when using the ratio to compare different companies with one another. Businesses differ substantially between industries, therefore comparing the current ratios of companies across different industries may not lead to productive insight.
For example, in one industry it may be more typical to extend credit to clients for days or longer, while in another industry, short-term collections are more critical. Ironically, the industry that extends more credit may actually have a superficially stronger current ratio because their current assets would be higher.
It is usually more useful to compare companies within the same industry. Another drawback of using current ratios, briefly mentioned above, involves its lack of specificity. For example, imagine two companies which both have a current ratio of.
On the surface this may look equivalent but the quality and liquidity of those assets may be very different as shown in the following breakdown: In this example Company A has much more inventory than Company B, which will be harder to turn into cash in the short-term.
Perhaps this inventory is overstocked or unwanted, which may eventually reduce its value on the balance sheet. Company B has more cash, which is the most liquid asset and more accounts receivable which could be collected more quickly than inventory can be liquidated.
Although the total value of current assets match, Company B is in a more liquid, solvent position. The current liabilities of Company A and Company B are also very different. Company A has more accounts payable while Company B has a greater amount of short-term notes payable.
This would be worth more investigation because it is likely that the accounts payable will have to be paid before the entire balance of the notes payable account.
However, Company B does have fewer wages payable, which is the liability most likely to be paid in the short term.
The observation that high turnover could be either good or bad reinforces the point that ratio computation is the starting point for financial statement analysis -- not the final point. Out-of-line ratios are “red flags” that call for an explanation. Free Investment and Financial Calculator using concepts like Time Value of Money, Net Present Value and Internal Rate of Return. Shareholder Letter. Dear shareholders, customers, partners and colleagues: It’s been a remarkable year for all of us at Microsoft, a year of change and opportunity for our company, our industry and the world.
In this example, although both companies seem similar, Company B is likely in a more liquid and solvent position. An investor can dig deeper into the details of a current ratio comparison by evaluating other liquidity ratios that are more narrowly focused than the current ratio.
A company that seems to have an acceptable current ratio could be trending towards a situation where it will struggle to pay its bills.Price/Earnings Ratio is a widely used stock evaluation measure.
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