This current ratio calculator can help you measure a company’s liquidity position by estimating the proportion of its current assets against its current liabilities. Below the form there is in depth information about the formula applied.
How does this current ratio calculator work?
In accounting and audit the current ratio demonstrates a company’s ability to pay its short term liabilities in due time by making use of its current assets that are sufficient liquid to be transformed in cash.
It measures the liquidity position of an entity by finding the proportion of current assets (cash, near cash and/or sufficient liquid assets) in relation to its current liabilities which are the ones due within 12 months or a single business cycle.
It is a figure that aims to show at which extent a business has enough financial resources by its assets to repay its short term debts and obligations, thus is used by lenders and creditors to evaluate whether the business can obtain short term loans or to assess how efficient is the business in converting its current assets into cash within a business cycle.
In the specialty literature the current ratio is also referred to as liquidity ratio or as working capital ratio and its formula is explained below:
Current Ratio (CUR) = Current Assets / Current Liabilities
Current assets represent cash, inventory, receivables and similar enough liquid assets.
Current liabilities refer to any debts and payables due in less than 1 year.
The interpretation of the current ratio level
Generally speaking the higher (usually above 1) the ratio is the better since it indicates that the company is able to pay in full and in due time its short term obligations by using its own current assets. However please note that the current ratio level should be interpreted considering the structure/allocation of the current assets and taking account as well of the industry or the market the company being analyzed operates in. For instance, if the current assets consist in their majority of cash, marketable securities or collectible accounts receivables then the more liquid the company is than consisting of inventories with a low possibility to be quickly converted into cash.
An optimal level is considered to be 2 (or 200%) as it demonstrates that the current assets a company owns (no matter of their composition and level of liquidity) are twice greater than its current liabilities which means there are no risks that the company will face default on a short run.
In practice, companies tend to maintain a current ratio of at least 1 that they consider sufficient safe to cover the amount of their short term debts. However, a current ratio greater than 1 is desirable as it shows the company can deal with unpredicted or unexpected liabilities and debt that may arise in the short term or within a business cycle.
A ratio below 1 may indicate that the company would be unable to repay in due time its short term liabilities, but that does not necessarily mean it will face bankruptcy since it may take other short term loans to repay the existing ones or it may request capital infusion from its stakeholders. However, there are industries in which a current ratio below 1 may be interpreted as an acceptable level. For instance this is applicable in case of big retail companies since they are able to negotiate long payment periods with their suppliers while collecting their receivables from clients in a shorter term.
Example of a current ratio calculation
If a company's current assets are estimated at $500,000 and its current liabilities are $300,000 then the current ratio displayed by this calculator would be $500,000 /$300,000 = 1.66 (166.67%).09 May, 2015 | 0 comments