The "current ratio" is the measure of a company's ability to pay off its obligations and liabilities in the short term. It is crucial in determining the financial health of a company. In general, a company is considered healthy if the "current ratio" is 2/1, ie its current assets are twice as high as its liabilities. A ratio of 1, which means that the company's assets and liabilities are equal, is considered acceptable. Lower ratios indicate that the company would not be able to pay its obligations.
Steps
Method 1 of 2: Understanding the Current Ratio
Step 1. Understand Current Liabilities
The term "current liabilities" is used frequently in accounting to refer to the obligations of businesses that must be paid in cash within a year or within a company's operating cycle. These obligations are governed by current assets or by the creation of new current liabilities.
Examples of current liabilities are short-term loans, accounts payable, trade payables and accrued liabilities
Step 2. Understand Current Assets
The term "current assets" refers to assets whose objective is to pay a company's obligations and liabilities within one year. Current assets can also be converted into cash.
Examples of current assets are receivables, inventory, marketable securities and other liquid assets
Step 3. Know the basic formula
The formula for calculating the "current ratio" is simple: current assets (AC) divided by current liabilities (PC). All the numbers you will need should already appear in the company's balance sheet.
Method 2 of 2: Calculate the Current Ratio
Step 1. Calculate current assets
In order to calculate the "current ratio", you must first find the current assets of the company. To do this, simply subtract non-current assets from the company's total assets.
As an example, suppose we calculate the "current ratio" of a company with € 120,000 in total assets, € 55,000 in shares, € 28,000 in non-current assets and € 26,000 in non-current liabilities. To calculate current assets, simply subtract non-current assets from total assets: € 120,000 (total assets) - € 28,000 (non-current assets) = € 92,000
Step 2. Calculate the total liabilities
After calculating the company's current assets, you will need to find its total liabilities. To do this, subtract the company's total assets from total equity.
Going back to the previous example, to calculate the company's total liabilities you will need to subtract the net from the total assets: € 120,000 (total assets) - € 55,000 (shares) = € 65,000
Step 3. Determine Current Liabilities
After finding the total liabilities of the company, you can calculate the current liabilities: subtract the non-current liabilities from the total liabilities of the company.
In the example above, to calculate the company's current liabilities you will need to subtract the non-current liabilities from the total liabilities: € 65,000 (total liabilities) - € 26,000 (non-current liabilities) = € 39,000
Step 4. Find the "current ratio"
Once you have determined your current assets and current liabilities, you will need to enter the values in the "current ratio" formula: CR = AC / PC.
To end the previous example, you just have to divide the company's current assets by its current liabilities: € 92,000 (current assets) / € 39,000 (current liabilities) = 2,358. The "current ratio" of your company is therefore 2,358, indicating a financially sound business
Advice
- You can find the "current ratio" referred to by other names, including "liquidity ratio", "capital ratio" and "cover ratio".
- The higher the ratio, the more the company is able to pay its obligations.
