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What Is Current Ratio?

what is current ratio

Definition of Current Ratio

  • The current ratio or working capital ratio is a liquidity ratio that measures a firm’s ability to pay its short term liabilities.
  • Short term liabilities are debts or any obligation that is due within one year.
  •  An ideal current ratio is between 1.2 and 2. 
  • If the ratio is low, it means the firm does not have enough liquid assets to offset its short term liabilities.
  • If the ratio is high, it means the firm has too many liquid assets and is not utilizing them.

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What is the Formula for the Current Ratio?

  • The current ratio is calculated by dividing current assets by current liability.

Current ratio = Current asset / Current liabilities 

The Current Ratio in Rractice

  • Assume that Bleu waters has:
  • Current asset:
    • Cash $ 30,000
    • Account receivable $20,000
    • Marketable security $20,000
    • Prepaid expense $15,000
    • Inventory $15,000
  • Current liabilities:
    • Account payable $50,000
    • Term debt $30,000
  • Bleu waters’ current ratio is:
    • ($ 30,000 + $20,000 + $20,000 + $15,000 + $15,000)/ ($50,000 + $30,000)= 1.25
    • The firm has a good current ratio.

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