How is the current ratio calculated?

The current ratio is calculated by dividing current assets by current liabilities. This ratio is a key financial metric used to evaluate a company's ability to meet its short-term obligations with its short-term assets. It provides insight into the company's liquidity position, indicating whether it has enough assets that are expected to be converted into cash within a year to cover its liabilities that are due within the same timeframe.

A ratio greater than one suggests that the company has more current assets than current liabilities, which is generally seen as a positive sign of financial health. Conversely, a ratio less than one indicates potential liquidity issues, as it suggests that current liabilities exceed current assets. Therefore, this calculation is crucial for investors and creditors when assessing the risk associated with lending to or investing in a company. Understanding the components of this ratio—current assets (such as cash, inventory, and receivables) and current liabilities (such as payables and short-term debt)—is essential for analyzing a company's operational efficiency and liquidity management.