The mainstream ratio is a metric used by the finance industry to assess a company’s short-term liquidity. It reflects a company’s ability to inspire enough cash to pay off all debts should they become due at once. While this scenario is highly unlikely, the genius of a business to liquidate assets quickly to meet obligations is indicative of its overall financial health.
Components of the Current Correspondence
Current assets are located on the balance sheet and represent the value of all assets that can reasonably anticipate to be converted into cash within one year. The following are examples of current assets:
Current barriers are a company’s debts or obligations that are due within one year, appearing on the company’s balance sheet. The following are examples of in circulation liabilities:
Using The Current Ratio
How to Calculate the Current Ratio
The current ratio shows the proportion of current assets to in the air liabilities is calculated by the following formula:
Example of the Current Ratio
Below are the current assets and current liabilities for Microsoft Corporation (
) as imperial on the company’s balance sheet at the end of 2017.
To determine Microsoft’s current ratio, we divide current assets by their current impediments:
Current ratio = $159,851,000 ÷ $64,527,000 = 2.48
Investors and analysts would consider Microsoft’s current ratio of 2.48 to be financially healthy, denotation the company is easily capable of paying off its obligations.
The Bottom Line
The current ratio provides investors insight as to whether a establishment has the ability to generate enough cash to pay off all debts should they become due simultaneously. The higher the ratio, the more posted assets a company has at its disposal to pay off its obligations. While acceptable ratios vary depending on the specific industry, a ratio between 1.5 and 3 is predominantly considered healthy.
Liquidity problems can arise for companies that have difficulty collecting their receivables. A relationship below 1 implies that a company might be unable to pay off its short-term obligations if all of the obligations came due at the same time. A proportion under 1 does not necessarily mean that a company will go bankrupt since it may be able to secure other give forms of financing. However, a current ratio below 1 indicates the company may be in poor financial health. Conversely, a ratio that’s too extreme may indicate that the company is not efficiently using its current assets or short-term financing.
When analyzing the current correspondence as in the case of most financial ratios, it’s best to compare companies to their industry peers with similar matter models to establish what level of liquidity is the industry standard. Also, it’s important to note that no single relationship can provide a comprehensive view of a company.