Current Ratio Formula and Its Example
- 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 total current assets versus total current liabilities.
- It indicates the financial health of a company and how it can maximize the liquidity of its current assets to settle debt and payables.
- This current ratio is classed with several other financial metrics known as liquidity ratios. These ratios all assess the operations of a company in terms of how financially solid the company is in relation to its outstanding debt.
- Knowing the current ratio is vital in decision-making for investors, creditors, and suppliers of a company. The current ratio is an important tool in assessing the viability of their business interest.
Formula
Current Ratio = Current Assets / Current Liabilities
Example
Cash = 15,000
Marketable securities = 15,000
Inventory = 30,000
Short-term debt = 20,000
Accounts payables = 10,000
Current assets = 15,000 + 15,000 + 30,000 = 60,000
Current liabilities = 20,000+ 10,000= 30,000
Current ratio = 60,000 / 30,000 = 2.
Current Assets and Its Components
Current assets are resources that can quickly be converted into cash within a year’s time or less. They include the following:
- Cash – Legal tender bills, coins, undeposited 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 – Debt that is maturing within a year
- Other receivables – Insurance claims, employee cash advances, income tax refunds
- Inventory – Raw materials, work-in-process, finished goods, manufacturing/packaging supplies
- Office supplies – Office resources such as paper, pens, and equipment expected to be consumed within a year
- Prepaid expenses – Unexpired insurance premiums, advance payments on future purchases
Current Liabilities and Its Components
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 the 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, and anything else that has been accrued for but an invoice is not received.
- Deferred revenue – Revenue that the company has been paid for that will be earned in the future when the company satisfies revenue recognition requirements.
