Current Ratio Definition, Formula with Example – How to Calculate It?
When anyone says about current ratio, then it is said that it is the liquidity ratio. The ratio is seen to be helping your company’s ability so that the company can pay short-term obligations. It helps the investors to know as well as analysts about how the company can get maximize about the current assets as well as about its balance sheet to satisfy all the existing debt.
What Is The Formula Used To Calculate The Current Ratio?
If you are thinking to calculate the current ratio, then it can be done by dividing the existing assets with the current abilities. The rate that you get is said to be stated in numeric format, and it can be coming in the decimal format. If you are searching the formula for calculation then here is the formula for you. With the help of this formula, you can easily get the current ratio.
Current ratio= Current Assets/ Current Liabilities
How Is It Calculated?
When you go for calculating the ratio, you need to make sure that it compares with the company’s current assets as well as with the current liabilities. You can easily find all the existing assets of a company as all those are listed on the company’s balance sheet. There you can get all the data for all accounts, cash interactions, inventory, and other assets too and all of it are said to be expected in liquidated or can be turned into cash in less than one year. When you go for the current ratio, you can see that it exist there like a line where it shows that average or higher industry. If you get the low current ratio than the industry average, then it leads to the high risk of distress. But in case the current ratio is high, then it shows that the management is not going to use the assets effectively.
How Are The Current Ratio And Debt-Related?
If anyone asks about how the current ratio and debt are related then to understand it in a better way you need to realize that a company which has got the current ratio is said to be less than one. But also you can see that in most of the cases, the capital that exists on the hand that helps in meeting all the short-term obligations. All these things are placed in at once, and in these, all, the current ratio is said to be higher than one. With this, it helps in indicating that the company has got the financial resources which remain insolvent and that too in the short-term. But if you go through the current condition, then the current ratio exists there at one time is said to be like the snapshot. With all these things in place, you can say that all these things are like the representation of the company’s solvency in the real world.
Example Of It:
If you are thinking about it profoundly or can’t get the points in a better way, then by going through the model, you can understand it in a better manner. Here you can assume that a company may have got a high current ratio and all the accounts receivable may get aged, or even sometimes the customers get pay slowly. So, an analyst needs to consider these things for other assets as well as its obligations. So, if the inventory is said to be unable to get sold, then the current ratio will start to look acceptable in time, and the company will then head towards the default.
How To Interpret The Current Ratio?
To interpret the current ratio, you need to the ratio under 1. It indicates that the company’s debts, which are due in a year or less, are said to be higher than the company’s assets. If you take a look at it, then the higher current ratio will excellently help you, and also it is capable that a company is now paying obligations as it has got the more significant proportion of all short-term asset value and it is relative to the amount of all short-term liabilities. If you get the ratio more than 3, then it can help you in indicate the company can cover all the current liabilities which comes with three times as well as it can indicate that you are not using any of the existing assets effectively and also it is not managing in a good working capital.
What Are The Limitations Of Using The Current Ratio?
If you are going for using the current ratio, then to use that there are many limitations. Some of the limitations that you must know about it are mentioned below.
- The first limitation that you must use is about the current ratio emerges, and when it is used the ratio, it helps in comparing with all different companies with each other. If you look at the business, differ between industries, and it compares with current ratios of all companies that exist across the sectors which may not lead to productive insight.
- If you look at the current ratios, then it too involves some lack of specificity. When they are taken into consideration, then you many see that all liquidity ratios as well as it helps in incorporating all the company’s current assets and also to those who all can’t be easily liquidated.
- You can be more involved in the investigation, and the accounts are likely very much payable, and you need to get paid for the entire balance of the notes as well as another payable account.
So, here in this article, you can see that all the necessary things starting from calculation to its limitations all are mentioned above. In case you have got the doubt over anything about the Current Ratio, then you can get it clear from here. The calculation of Current ratio is too given with example, and everything possible thing is taken into account for you so that you can understand excellently.
Sudha is the senior publisher at Finance Glad. Sudha completed her education in BBA (Bachelor of Business Administration). She lives in Chennai. She is currently heading towards the banking topics. Sudha is an expert in analyzing and writing about most of the banks and credit card reviews. Sudha main hobbies and interests are reading, writing and watching the quality stuff over the internet. She usually wants to learn more productive stuff and share the best information to her readers over the internet via Finance Glad.