Current Ratio is the liquidity ratio which is used to measure the ability of the firm to pay off its short term liabilities with its current assets. it is also called the efficiency ratio. As short term liabilities within the next year so it is an important measure of the liquidity.
To pay the fund for these liabilities there is limited time for the company. In the short term cash equivalent, marketable security can be converted in the cash to pay for these liabilities. So the company which has a large number of assets can easily pay off the current liabilities in short term without the selling of long term revenue generated assets.
When we divide the current assets with current liabilities then we get the current ratio and it is in the numeric format instead of decimal form.
Current ratio= Current assets/current liabilities
- GAAP required that on the balance sheet to separate the long term and short term assets and liabilities because of which creditor and analyst can calculate the important ratio like the current ratio. This ratio uses to express the current debt of firm in term of current assets.
If the current ratio of the company is 3 then it means that as compared to current liabilities the company has 3 times greater current assets. So the current ratio used to measure the liquidity of the company and how easily the company pays off its current liabilities.
The high current ratio is the best for the company as compared to the low current ratio of the company. Because it shows how easily a company makes the current debt payment.
If for the payment of current liabilities company sells its fixed assets then the performance of the company is not good to making enough money from operation to support activity. This may be because of the poor receivable accounts of the company.
Bell has a skate shop. he sales ice skating equipment to the hockey team. To expand his business he applies for the loan. Bank get the information from the balance sheet to analyze the current debt of his shop. Those pieces of information are listed below
- Current liabilities = $100,000
- Current Assets = $25,000
Now we put above values in the formula of current ratio as
From the above result, we can say that bell has enough current assets to pay 25% of his current liabilities. The current ratio for the bell to get the loan is not good because for loan current ratio require 1 or 2 so that all the current liabilities covered by the current assets.
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