Current Ratio

Current ratio is the most popular and fundamentalfinancial accounting ratio. It shows the company ability to repay its short term liabilities. It can be calculated by dividingcurrent assetsby current liabilities. In order to run business without any cash flow problems, the current liabilities should be equal to or less than the current assets.

Current assets are the assets which are convertible to cash or cash equivalents within a period of 12 months. Mostly, current assets involve cash in hand, cash at bank, marketable securities, short term investments, notes receivable, accounts receivable, prepayments andinventories/ stock.

Current liabilities are liabilities which the company has to pay with next 12 months. Mostly, current liabilities include wages payable, salaries payable, sales tax payable, accounts payable, notes payable, accrued expenses and current year tax liability.

Current Ratio Formula

C.A = Current Assets / Current Liabilities

Current Ratio Analysis

As mentioned above, the current asset should be more than the current liabilities in order to carry on as a going concern. Usually, this C.A ratio must be equal to 1 or more than 1. If it is lower than 1, and then we can easily say that the company is suffering from severe cash flows as it is unable to meet its current liabilities.

Example

Calculate current ratio from the following data of XYZ Co:

Accounts receivable = $50,000

Cash = $10,000

Notes Receivable = $12,000

Marketable securities = $10,000

Accounts Payable = $20,000

Notes Payable = $22,000

Accrued Expenses = $24,000

Sales tax payable = $17,000

Solution

First we will calculate current assets and current liabilities:

Current assets= accounts receivable + cash + notes receivable + marketable securities =

= 55,000 + 10,000 + 12,000 + 10,000 = $87,000

Current liabilities= accounts payable + notes payable + accrued expenses +sales tax payable

= 20,000 + 22,000 + 24,000 + 17,000= $83,000

Current Ration = Current assets / current liabilities

Current ratio = 87,000 / 83,000 = 1.04