The current ratio measurement tells us about the ability of the company’s short term debt paying. This ratio is computed by dividing total current assets by total current liabilities. Current ratio shows whether the current assets of a company are greater or less than its current liabilities. Formula for calculating current ratio is given as:
Current Ratio= Current Assets / Current Liabilities
For example: Asifo Company has total current assets of $1,000,000 and the total current liabilities of $550,000. The current ratio of Asifo Company is 1.82 to 1.
Current Ratio = 1,000,000/550,000 = 1.82
A current ratio of 1.8 to 1 indicates that the Asifo Company’s current assets are 1.82 times greater than its current liabilities. It also indicates that the company has 1.8 times ability to pay its short term debts or company has $1.8 to pay the short term debt of $1.
Solvency of the company is identified from its current ratio. Higher the current ratio the more solvent company is, whereas lower the current ratio the lower solvent company appears. Many short term creditors and bankers believe that retailers must have current ratio of 2 to 1 to qualify for good credit risk.
Average current ratios of different industries are given below for recent years