Current Ratio

by Investing School on November 8, 2009

A current ratio is a financial formula. It measures the ability of a company or corporation to pay back its debts over a 12 month cycle. It will calculate the ratio between a company’s current assets to its current liabilities.

This is how it works: a company’s current assets will be divided into its current liabilities. The outcome is the company’s current ratio. For example, if XYZ’s company had a current asset total of $100,000 and its current liabilities were $80,000 then its current ratio would be 1.25. More specifically, it means that for every dollar that the company has to pay back it has $1.25 available in its current assets.

A company’s current ratio is used as an indicator of its market liquidity. If it has a high current ratio then the company is able to easily meet creditor’s demands. Current ratios are different according to various industries. For example, if a company has a ratio below 1 then it may have difficulty meeting obligations. However, if the ratio is too high then this is an indicator that the company is not properly or efficiently using its current assets.

It is important to note that low values do not necessarily indicate problems. If a company has solid long-term projects then it may be able to borrow against some of these projects to meet some of its current obligations.

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