Question

Please provide at least 2 reasons why 2:1 current ratio might not be adequate for a particular company. Thanks!

Answer 1

Two reasons why 2:1 current ratio might not be adequate

1) 2:1 current ratio may not be adequate if the company's current assets consist of a large proportion of slow turning accounts, notes and merchandise inventory. The slow running current assets make it difficult to realise cash from current assets and resultantly it becomes difficult to pay its current liabilities in due time. Therefore, 2:1 current ratio might be inadequate for the company.

2) A 2:1 current ratio would not be adequate if the company is facing some mid term obligations coming due that were not reflected on the current liabilities of the balance sheet. Current liabilities are obligations due in one year or less. If the company has to cover a large debt two years from now, and it does not look like the company will have enough liquid assets to pay it, a 2:1 current ratio might be a sign of trouble.

Thus the above mentioned points can be the reasons for which 2:1 current ratio might not be adequate for a particular company.