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Indicates how well a company could pay its current liabilities with all of its current assets.[sc:kit02 ]
Current Ratio Formula
Explanation of Current Ratio
The current ratio compares all the Total Current Asset of a company to all the Total Current Liabilities. What this ratio basically tells us is if the company had to sell all its readily available assets, would it be able to pay off its immediate debt?
Importance of Current Ratio
At a minimum, you would hope the company whose financial performance you are analyzing could meet pay its Total Current Liabilities if it were to liquidate all its Total Current Asset. This would translate to a Current Ratio of 1.0 – the point where the Total Current Assets equal the Current Liabilities.
As with all the other performance ratios, the Current Ratio value depends on the industry in which the company is operating. It is also important to know what assets make up most of the Total Current Asset. Inventories and Accounts Receivable, which are part of the Current Assets, cannot always be counted on as easily transferred to cash. Cash and Marketable Securities comprising the majority of the Current Assets would definitely be favorable.
Knowing this, would the company you are analyzing truly be able to meet its financial obligations is it in fact had to sell its Current Assets? The Current Ratio rising over time will be favorable.