How is the current ratio calculated?

The current ratio is calculated by dividing current assets by current liabilities. This financial metric is used to assess a company's ability to pay off its short-term obligations with its short-term assets. Current assets typically include cash, accounts receivable, and inventory, which are all assets that can be converted into cash or used up within a year. Current liabilities encompass debts and obligations that are due within the same time frame, such as accounts payable and short-term loans.

By evaluating the relation between current assets and current liabilities through this ratio, stakeholders can gauge financial health and liquidity. A current ratio greater than one indicates that the company has more current assets than current liabilities, suggesting it should be able to meet its short-term obligations comfortably. Conversely, a ratio of less than one may raise concerns about potential difficulties in covering short-term debts. This fundamental assessment helps investors, creditors, and management understand the liquidity position of a business.