What Is the Current Ratio?

The current ratio is an important financial metric that measures a company’s ability to pay its short-term obligations, such as accounts payable and debt. It is calculated by dividing a company’s total current assets by its total current liabilities. A current ratio of 1.00 or greater is generally considered a good indication of financial health, since it signifies that the company has a sufficient amount of assets to cover its liabilities.

Examples of the Current Ratio

For example, let’s assume that Company A has $20,000 in current assets and $10,000 in current liabilities. The current ratio would be $20,000/$10,000, or 2.0. This means that Company A has $2 of assets for every $1 of liabilities, and thus is likely in good financial health.

Alternatively, let’s assume that Company B has $8,000 in current assets and $15,000 in current liabilities. The current ratio would be $8,000/$15,000, or 0.5. This indicates that Company B is not in good financial health, since it only has half a dollar of assets for every one dollar of liabilities.

Conclusion

The current ratio is an important financial metric that can indicate a company’s financial health. Companies that have a current ratio of 1.00 or greater are usually in good standing, while those with a ratio lower than 1.00 can be in trouble. Knowing and understanding the current ratio can give college students a better understanding of business and finance.