Current Ratio - The Patriarch Ratio

Current ratio (the ratio of current assets to current liabilities) was perhaps the earliest ratio to gain widespread use as a measure of solvency. On the theory that $2 in current assets could safely cover $1 of current liabilities (with enough remaining to operate) a 2-to-1 value became an inflexible standard. But inventories can vary greatly in their liquidities. Oil, for example, can be rapidly liquidated, but inventories of service parts could take years to sell -- hardly "current assets". Also, small businesses can often liquidate their inventories more rapidly than large ones, indicating that current ratio may not be comparable for different size firms. Moreover, the relative investment in inventory rose from 77% of working capital to 83% of working capital between 1950 and 1962 for American corporations [Miller,1966]. Just-In-Time (JIT) inventory control using computers has dramatically decreased the amount of inventory held. Thus, indicators from the past might not be useful for the future. A 1-to-1 "acid-test" ratio which excluded inventory from current assets was a suggested replacement for current ratio, but the liquidity of the receivables portion of current assets is still open to question without information on collectability. In a strike or a recession, the business might have to pay its current liabilities by liquidating its current assets. Yet it is questionable if this could be done without a loss in operating capacity -- especially serious in a recession. In the case of an airline, cash flows are more a function of its current assets than of its non-current assets.