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Current Ratio Formula

Current Assets / Current Liabilities

What is the Current Ratio?

The current ratio, also known as the working capital ratio, measures the capability of a business to meet its short-term obligations that are due within a year. The ratio considers the weight of the total current assets versus the total current liabilities. It indicates the financial health of the company, and how it can maximize the liquidity of its current assets to settle debt and payables.  The Current Ratio formula (below) can be used to easily measure a company’s liquidity.

 

current ratio formula diagram

 

Current Ratio formula

The Current Ratio formulas is:

Current Ratio = Current Assets / Current Liabilities

 

Example of the Current Ratio formula

If a business has:

  • 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 this 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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What are Current Assets?

Current assets are resources that can quickly be converted into cash within a year’s time or less. These include the following:

  • Cash – legal tender bills, coins, un-deposited checks from customers, checking and savings accounts, petty cash
  • Cash equivalents – corporate or government securities with 90 days or less maturity.
  • Marketable securities – common stock, preferred stock, government and corporate bonds with a maturity date of 1 year or less.
  • Accounts receivable – money owed to the company by customers and that is due within a year. This net value should be after deducting an allowance for doubtful accounts (bad credit)
  • Notes receivable maturing within a year
  • Other receivables – such as insurance claims, employee cash advances, income tax refunds
  • Inventory – raw materials, work-in-process, finished goods, manufacturing/packaging supplies
  • Office supplies
  • Prepaid expenses – unexpired insurance premiums, advance payments on future purchases

 

What are Current Liabilities?

Current liabilities are business obligations owed to suppliers and creditors, and other payments that are due within a year’s time. This includes:

  • Notes payable – interest and principal portion of loans that will become due within one year
  • Accounts payable or Trade payable – credit resulting from the purchase of merchandise, raw materials, supplies, or usage of services and utilities.
  • Accrued expenses – payroll taxes payable, income taxes payable, interest payable

 

Why use the Current Ratio formula?

This ratio is classed with several others known as liquidity ratios. These ratios all assess the operations of a company and how financially solid the company is in relation to its outstanding debt. Knowing the ratio is vital in decision-making for investors, creditors, and suppliers of a company. When it comes to these parties, the current ratio is an important tool in assessing the viability of their business interest.

Learn more about the current ratio formula with a real example from Lions Gate Entertainment.

 

 

Additional resources

Thank you for reading this guide to understanding the current ratio formula. To keep educating yourself and advancing your finance career, these resources will be helpful:

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