Current ratio, also known as the working capital ratio, measures the potential of a business on meeting 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 health of the company, and how it can maximize on the liquidity of its current assets to settle debt and payables.
The Current Ratio formulas is as follows:
If a business has:
Current assets = 15 + 20 + 25 = 60 million
Current liabilities = 15 + 15 = 30 million
Current ratio = 60 million / 30 million = 2
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.
Current assets are resources that can quickly be converted into cash within a years time or less. This includes:
Current liabilities are business obligations owed to suppliers and creditors, and other payments that are due within a year’s time. This includes:
This ratio is classed with several others known as ‘liquidity ratios.’ These ratios all assess the operations of a company, and how readily it will be able to save itself when debt is called. 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.