The Current Ratio is the ratio of the firm’s current assets and current liabilities. In short, it provides a picture of the relationship between its current assets and current liabilities and can put forth the firm’s ability to pay its short-term debts. This is a widely used measure for evaluating the liquidity and debt-paying ability of any company.
It permits people to compare the liquidity of different-sized companies and of a single company at different times. It does not take into account the composition of the current assets. So the formula to calculate this particular ratio is listed below -
Current ratio = Current assets / Current liabilities
It is sometimes referred to as the working capital ratio. Working capital is current assets minuscurrent liabilities. This type of ratio is a more dependable indicator of liquidity than working capital. Two companies with the same amount of working capital may have significantly different current ratios.
For example, a satisfactory current ratio does not disclose the fact that a portion of the current assets may be tied up in slow-moving inventory. A dollar would be more readily available for paying the bills than to a slow-moving inventory. It is an expression of a firm’s ability to repay its current debts from its current assets.
Use of the Term in Sentences
- Investors are interested in the current ratio of businesses before deciding to invest in them; it represents the credibility of the company in the respective market.