If you look back at Indian companies that got into trouble, in most cases it was an outcome of poor working capital management. One of the keys to working capital management is the current ratio. It is said that really solid good companies manage their working capital efficiently and the current ratio is all about how the working capital of the company is managed. Every manufacturing company needs a positive working capital. That means your short term liabilities must be funded with short term assets to avoid putting your long term assets under pressure. The current ratio is, therefore, a basic measure of solvency. Lenders generally want to see a 2:1 current ratio or better, although very high current ratio is not a very encouraging sign. Let us look at the formula for current ratio here.

Current Ratio = Current assets (cash, receivables, and inventory) / current liabilities.

The problem with the current ratio is that it includes inventories as assets and quite often such inventories may not have a ready secondary market. That is where the quick ratio comes in handy. The quick ratio is nothing but the current ratio without the inventory. The quick ratio tells you if you have enough readily available funds to cover short-term obligations. It should be at least 1:1 for manufacturing companies to give comfort. The logic is that inventory, being specialized, is the least liquid of the various assets classes within the current assets spectrum.