Definition Definition

What Is the Current Ratio? Understanding the Current Ratio with Example

What Is the Current Ratio?

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. 

Understanding the Current Ratio

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.

 

Example

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.

 

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