Current Ratio

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Measuring liquidity. Explanation of Current Ratio.

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Current Ratio Calculation LiquidityThe Current Ratio (CUR) method is a model for measuring the liquidity of a company. It is calculated by dividing all current assets by all current liabilities. It is an indicator of a company's ability to pay short-term obligations.
 

Current Ratio formula

For the Current Ratio formula, see the picture on the right.

This ratio is also known as the working capital ratio and real ratio and is the standard measurement of a business' financial health. It will tell us whether a company is able to pay its current obligations by measuring if it has enough assets to cover its liabilities.


Example of Current Ratio calculation

For example, if a corporation has M$50 in current assets to cover M$50 in current liabilities, this means that it has a Current Ratio of 1.


What is an acceptable Current Ratio?

This varies by industry. Generally speaking, the more liquid the current assets, the smaller the CUR can be without cause for concern. For most industrial companies, 1.5 is an acceptable CUR. A standard CUR for a healthy business is close to two. This means the company has twice as many assets as liabilities.


A thing to remember when using the CUR is that it ignores timing of both cash received and cash paid out.

Take the example of a company with no bills due today, but lots of bills that are due tomorrow. The company also owns a lot of inventory (as part of its current assets). However the inventory will only be sold in the longer term. This company may show a good Current Ratio, but can not be considered as having a good liquidity.


Book: Steven M. Bragg - Business Ratios and Formulas : A Comprehensive Guide -

Book: Ciaran Walsh - Key Management Ratios -


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