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VMC: What Is Current Ratio?

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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.

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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DISCLAIMER: This content is for information purposes only. It is not intended to be investment advice. Readers should not consider statements made by the author(s) as formal recommendations and should consult their financial advisor before making any investment decisions. While the information provided is believed to be accurate, it may include errors or inaccuracies. The author(s) cannot be held liable for any actions taken as a result of reading this article.