In the example above, Firm A has good liquidity with a current ratio of 2.00. It must hold more current assets, thus increasing its total assets. So, for every $1.00 of current liabilities, there are $0.93 of current assets. Creditors are interested in the current ratio and other liquidity ratios since higher values show a greater probability of repayment. Higher values show greater liquidity and a stronger financial position.
Outside of a company, investors and lenders may consider a company’s current ratio when deciding if they want to work with the company. For example, this ratio is helpful for lenders because it shows whether the company can pay off its current debts without adding more loan payments to the pile. For example, if a company has $100,000 in current assets and $150,000 in current liabilities, then its current ratio is 0.6. You’ll want to consider the current ratio if you’re investing in a company.
Current Liabilities
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- It is also known as the working capital ratio, and it is one of the most commonly used ratios in financial analysis.
- The sale of inventory will generate substantially more cash than its value on the balance sheet if it is sold for more than the cost of acquiring it.
- Within the current ratio, the assets and liabilities considered often have a timeframe.
- These include highly liquid assets like cash and marketable securities, but also less liquid assets, like inventory.
- It is not difficult to understand why it is considered the best ratio because we have more assets than our liabilities.
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Current Ratio Formula and Examples
XYZ Company had the following figures extracted from its books of accounts.
Whether you incorporate the current or the quick ratio into your financial analysis depends primarily on your business model and the time horizon over which you’re trying to investigate your company’s liquidity. Let’s talk about an example that is going to illustrate the current ratio. Ok, so let’s assume that company A has Six million dollars in currents assets. Furthermore, Company B also possess six million dollars in its current assets. To calculate current ratio of a company we need to divide the current assets to liabilities of the respective company. It is a valuable tool for businesses and investors alike, as it provides a quick snapshot of a company’s financial health.