Current Ratio is one of the most heard terms in Accounting. However, there are more meaning and use of current ration than that. Well, Current Ratio is basically a liquidity ratio which helps in measuring the ability of the company to pay obligation that is short term or limited in one year. It helps the investors as well as an analyst to understand how the company is going to maximize their current assets to satisfy their current debt as well as payables in the balance sheet.
Current Ratio and its Formula, Analysis and Example
Current Ratio is also called a Working capital ratio. For understand the company’s ability to pay out the short-term obligation that is limited to one year, this formula can be used. The weight of total current asset versus the current liabilities total is the ratios weight considered. Well, it shows the company’s financial health and how liquidity current assets maximization can be settle to debt or the payables. Here is the formula that can be simply used to get the liquidity of the company.
Current Ratio = Current Assets / Current Liabilities
For example, if the business has the current asset of $200 and current liabilities is $ 100.
The calculation is going to be $200/$100= 2.00X
Here the X (times) indicates the company is able to pay the current liabilities from their current assets for over two times
Know what the current assets are: It’s a resource which can be easily converted into cash. It can easily do taking only one year or lesser than that. Well the list of current assets that you can consider is: Cash, accounts receivables, marketable securities, cash equivalents, inventory, notes receivable, office supplies and prepaid expenses
Know what are the current liabilities: Its an obligation in business that is owed to the creditors, suppliers and other kinds of payments which are due in one year. It includes notes payable, deferred revenue, accounts payable, and accrued expenses
Why is the CR Formula Used?
There are several different financial metrics, which is also called a liquidity ratio, Current Ratio also belongs to that group. Well, these kinds of ratios are to assess the company’s operation and understanding its terms regarding how much company is strong regarding financially. It’s important for investors to understand the current Ratio of the company as it also assesses the business interests; viability too. There are some other important liquidity ratios that can be added, such as Acid test ratio and Quick Ratio.
There are different advantages too, such as knowing how much the company is cash-rich. If the Ratio is high, then it means the company is in a stable state; however, if the ratio is low, then it’s risky to associate with that company. Along with that, it also gives an overlook of the operating cycle of the company. It helps in knowing the ability of the company and its selling. It also helps in knowing the efficiency of management and how fast they can meet the demands of creditors.