What is Current Ratio | Calculate | Formula | Example 2021:-The current ratio is a liquidity and regulation ratio that measures a firm’s ability to pay off its short-term liabilities with its current assets. The current ratio is an important measure of liquidity because short-term liabilities are due within the next year. This means that a company has a limited amount of time in order to raise the funds to pay for these liabilities. Current assets like cash, cash equivalents, and marketable securities can easily be converted into cash in temporarily.
This means that companies with larger amounts of current assets will more easily be able to pay off current liabilities when they become due without having to sell off long-term, revenue-generating assets.
The formula of the Current Ratio:
The current ratio is computed by splitting the total current assets by the total current liabilities of the business. This relationship can be expressed in the form of the following formula or equation:
What is the Current Ratio?
The current ratio of a firm measures the ability to pay its current or short-term liabilities with its current or short-term assets. It is also known as ‘working capital ratio. From the various assets available, only current assets are considered for the current ratio calculation. Current assets are the possessions of the company that is easily convertible to cash within a year. On the other hand, short liabilities that are due for payment within a year fall under current liabilities.
Current Ratio formula
Current Ratio = Current Assets / Current Liabilities
How To Calculate Current Ratio
You calculate your business’ overall current ratio by dividing your current assets by your current liabilities.
Current assets (also called short-term assets) are cash or any other kind of asset that will be converted to cash within one year. You can find them on the balance sheet, alongside all of your business’ other assets.
Current Ratio=Current Liabilities/Current Assets
Components of the Current Ratio
The current ratio is a liquidity ratio that is computed by dividing current assets by current liabilities. Therefore, the two main components of the current ratio are current assets and current liabilities.
Current assets can be found on a company’s balance sheet and represent the value of all assets it can reasonably expect to convert into cash within one year. The following are examples of current assets:
- Accounts receivable
- Cash and cash equivalents
- Marketable securities
- Prepaid expenses
The current assets figure is different from a similar figure called total assets, which also includes net property, equipment, long-term Investments, long-term notes receivable, intangible assets, and other tangible assets.
Current liabilities are a company’s debts or obligations that are due within one year, appearing on the company’s balance sheet. The following are examples of current liabilities:
- Short-term debt
- Current portion of long-term debt
- Accounts payable
- Accrued liabilities like dividend, income tax, and payroll
Example of Current Ratio
If a business holds:
- Cash = $15 million
- Marketable securities = $20 million
- Inventory = $25 million
- Short-term debt = $15 million
- Accounts payables = $15 million
Current assets = 15 + 20 + 25 = 60 million
Current liabilities = 15 + 15 = 30 million
Current ratio = 60 million / 30 million = 2.0x
The business currently has a current ratio of 2, meaning it can easily settle each dollar on loan or accounts payable twice. A rate of more than 1 suggests financial well-being for the company. There is no upper-end on what is “too much,” as it can be very dependent on the industry, however, a very high current ratio may indicate that a company is leaving excess cash unused rather than investing in growing its business.
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