Current Ratio: Calculation, Formula & Examples

how to calculate current ratio

The current ratio indicates a company’s ability to meet its short-term obligations. The ratio’s calculated by dividing current assets by current liabilities. Current assets are all assets listed on a company’s balance sheet expected to be converted into cash, used, or exhausted within an operating cycle lasting one year.

Therefore, it is critical for such companies to maintain a good liquidity position in order to ensure their profitability. From the balance sheet, one can infer that the company’s current assets were worth $161,580, and the current liabilities were $142,266. Let’s find the company’s ratio by implementing the current ratio formula. You can calculate the current ratio – also known as the current asset ratio – by dividing current assets by current liabilities. This is easy to set up on a balance sheet template using tools like Excel or Google Sheets. Remember to only include current assets and liabilities in your total – no long-term investments or debt.

Your current liabilities (also called short-term obligations or short-term debt) are:

Based on the calculation above, it can be concluded that for every dollar in current liabilities, the company has only $0.5 in current assets. This indicates that the business is highly leveraged and how to calculate current ratio carries a high risk. Therefore, investing in this company could potentially result in a loss for Alex. Summing up, mastering the art of calculating current ratios is a gateway to financial acumen.

Uncover how economic shifts and external factors influence the interpretation of current ratios. Explore the industry-specific benchmarks to assess whether your current ratio aligns with standards. Comparing a given company’s working capital ratio to other companies in a similar sector or industry is the best way to use the ratio. For example, comparing Apple’s (APPL) 2020 current ratio of 1.36 against Microsoft’s (MSFT) 2020 current ratio of 2.58 helps us determine that Apple’s ratio is weaker compared to its competitor. Inventory may be the largest dollar amount on the balance sheet, and a big use of your available cash.

Example of Current Ratio

It compares the ratio of current assets to current liabilities, and measurements less than 1.0 indicate a company’s potential inability to use current resources to fund short-term obligations. Additionally, some companies, especially larger retailers such as Walmart, have been able to negotiate much longer-than-average payment terms with their suppliers. If a retailer doesn’t offer credit to its customers, this can show on its balance sheet as a high payables balance relative to its receivables balance. Large retailers can also minimize their inventory volume through an efficient supply chain, which makes their current assets shrink against current liabilities, resulting in a lower current ratio. Current assets listed on a company’s balance sheet include cash, accounts receivable, inventory, and other current assets (OCA) that are expected to be liquidated or turned into cash in less than one year.

According to AMA Eljelly’s International Journal of Commerce and Management (2004), this study empirically investigates the tradeoff between liquidity and profitability in an emerging market. The study focuses on the relationship between liquidity and profitability, taking into account the effect of other variables. The study samples a total of 40 listed firms from the Saudi stock market, using financial ratios to measure liquidity and profitability. The findings of the study suggest that the Saudi stock market is characterized by a negative relationship between liquidity and profitability. The results also indicate that the liquidity-profitability tradeoff is affected by the size of the firm, leverage, and the age of the firm.

Current Ratio vs. Quick Ratio: What’s the Difference?

Investment decisions should be based on an evaluation of your own personal financial situation, needs, risk tolerance and investment objectives. The interpretation of the value of the current ratio (working capital ratio) is quite simple. Note the growing A/R balance and inventory balance require further diligence, as the A/R growth could be from the inability to collect cash payments from credit sales. Net sales refer to the profits made after deducting sales allowances, discounts, and returns. Average total assets refer to the average aggregate assets at the end of the current or previous fiscal year.

  • Now that you’ve reviewed the balance sheet accounts in detail, you can start to think about the financial health of your business.
  • A high current ratio, on the other hand, may indicate inefficient use of assets, or a company that’s hanging on to excess cash instead of reinvesting it in growing the business.
  • Let’s find the company’s ratio by implementing the current ratio formula.
  • The current ones mean they can become cash or be paid in less than a year, respectively.
  • If a company is unable to pay off its short-term debt, it can face a liquidity crisis and, in extreme cases, bankruptcy.
  • This would allow a company with aged inventory to use it to its advantage.

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