Working capital of a company is ₹ 21,28,000 and total debts are ₹ 42,50,000. If the company's long term debts are ₹ 27,30,000, then current ratio will be:

Question

Accepted Answer

The correct option is 4:
The Current Ratio is a vital liquidity ratio calculated as Current Assets divided by Current Liabilities (Current Assets / Current Liabilities). To solve this problem, we must first isolate the two components of the ratio from the given data. Current Liabilities (CL) are found by subtracting Long-Term Debts (₹ 27,30,000) from the Total Debts (₹ 42,50,000), yielding a CL of ₹ 15,20,000. Next, we use the Working Capital formula (Working Capital = Current Assets - Current Liabilities) to find Current Assets (CA). Rearranging the formula gives CA = Working Capital + Current Liabilities, which is ₹ 21,28,000 + ₹ 15,20,000 = ₹ 36,48,000. Finally, the Current Ratio is calculated as ₹ 36,48,000 / ₹ 15,20,000, which equals 2.4. Therefore, the Current Ratio is 2.4:1, indicating that the company possesses ₹ 2.40 in current assets for every ₹ 1.00 of current liabilities, a very strong short-term financial position.

The incorrect option is 1 (0.78:1):
This option incorrectly suggests that the company has poor short-term solvency, where its current assets are insufficient to cover its current liabilities. Mathematically, 0.78:1 would imply that Current Liabilities are much higher than the actual calculated Current Assets of ₹ 36,48,000 or that Current Assets are significantly lower than the calculated ₹ 36,48,000. For instance, if a student incorrectly took the ratio of Current Liabilities to Current Assets (₹ 15,20,000 / ₹ 36,48,000 $\approx$ 0.42:1), they would get a low figure, but not 0.78:1, demonstrating a significant calculation or conceptual error.

The incorrect option is 2 (1.4:1):
A current ratio of 1.4:1 is often considered acceptable in many industries, as it signifies a reasonable cushion for short-term obligations. However, this figure is not derived from the given financial data. This ratio might result from an entirely different, though incorrect, calculation, such as an attempt to find the ratio of Working Capital to Long-Term Debts or Total Debts to Current Liabilities. The correct calculation reveals that the company's liquidity position is stronger than this option suggests.

The incorrect option is 3 (1.14:1):
This ratio is too low for the correct Current Assets and Current Liabilities calculated. To obtain this result, one might have confused the components of the debt structure or made a significant miscalculation of the Current Assets value. For example, if a student mistakenly divided Current Assets by Total Debts, the resulting ratio would be approximately 0.86:1, which is still incorrect. This option is a distractor that represents a liquidity level far below the company's actual robust position.