Current ratio
The current ratio is a financial ratio that measures a company's ability to pay its short-term obligations with its current assets. It is calculated by dividing a company's current assets by its current liabilities. The current ratio indicates whether a company has enough short-term assets to cover its short-term liabilities. A healthy current ratio is usually considered to be around 2:1, which means that the company's current assets are twice its current liabilities. A current ratio below 1 indicates that a company may have difficulty in meeting its current obligations.
The current ratio is a financial ratio that measures a company's ability to pay its short-term liabilities with its short-term assets. It is calculated by dividing the company's current assets by its current liabilities.
The formula for calculating the current ratio is:
Current Ratio = Current Assets / Current Liabilities
Here's how you can calculate the current ratio step-by-step:
Step 1: Gather the financial statements.
Obtain the company's balance sheet or financial statements, which provide the balance of current assets and current liabilities.
Step 2: Identify current assets.
Current assets are assets that are expected to be converted into cash or used up within one year or the normal operating cycle of the business, whichever is longer. Examples of current assets include cash, accounts receivable, inventory, and short-term investments.
Step 3: Add up current assets.
Add up the values of all the current assets listed on the balance sheet.
Step 4: Identify current liabilities.
Current liabilities are obligations that are expected to be settled within one year or the normal operating cycle of the business, whichever is longer. Examples of current liabilities include accounts payable, accrued expenses, and short-term loans.
Step 5: Add up current liabilities.
Add up the values of all the current liabilities listed on the balance sheet.
Step 6: Divide current assets by current liabilities.
Use the formula mentioned earlier to divide the total value of current assets by the total value of current liabilities.
Step 7: Calculate the current ratio.
The result of the division will give you the current ratio. For example, if the current assets are $500,000 and the current liabilities are $300,000, the current ratio would be 1.67 ($500,000 / $300,000).
The current ratio is a measure of a company's short-term liquidity and is used by investors and creditors to evaluate a company's ability to meet its short-term obligations. A higher current ratio indicates a better ability to pay off short-term debts, while a lower ratio may suggest a potential liquidity issue.