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Contracts with lenders typically place restrictions on a company's activities in an attempt to ensure that the

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Contracts with lenders typically place restrictions on a company's activities in an attempt to ensure that the company will be able to repay both the interest and the principal on the debt owed to the lenders. These restrictions are frequently stated in terms of ratios. For instance, a restriction could be that the debt to equity ratio cannot exceed 1.0. If it does exceed 1.0, the debt covered by the restrictions becomes due immediately. Two commonly used ratios are the current ratio and the debt to equity ratio. Explain why these might be used as restrictions. How do they protect the lender?
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The current ratio is a financial ratio that measures a company\'s ability to pay its short-term obligations with its short-term assets. It is calculated by dividing a company\'s current assets by its current liabilities. The formula for calculating the current ratio is: Current Ratio = Current Assets / Current Liabilities Current assets are assets that can be converted to cash within one year, while current liabilities are debts that are due within one year. A current ratio of 1:1 or greater is generally considered good, as it indicates that a company has enough current assets to cover its current liabilities. A current ratio of less than 1:1 may suggest that a company may have difficulty meeting its short-term obligations. It\'s important to note that the current ratio is just one of many financial ratios that can be used to assess a company\'s financial health. It should be used in conjunction with other financial ratios and qualitative factors to make informed decisions about investing or lending to a company.

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