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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