Current Ratio Formula & Example

Definition: Current ratio (also known as working capital ratio) is the ratio of current assets of a company to its current liabilities. It is used to assess the working capital of a firm.

Formula:
Current ratio = Current Assets / Current Liabilities

* Current assets are the assets which can either be converted to cash or used to pay current liabilities within one year. Current liabilities are all liabilities of the business that are to be settled in cash within one year.

Example 1:
On 31 December 2010 James Ltd. had current assets of $1,200,000 and current liabilities of $600,000. Therefore, current ratio at that date = $1,200,000 / $600,000 = 2:1
A ratio of 2:1 means that for every $1 current liability, the firm has $2 in the form of current assets that can be converted into cash.

Example 2:
Following are the extracts from Smith Ltd's balance sheet as at 31 December 2008:
Trade debtors        $100,000
Trade creditors      $200,000
Bank overdraft       $50,000
Cash                      $700,000
Opening stock        $56,000
Closing stock         $200,000
Calculate the working capital ratio.

Answer:
Current assets = Closing stock + Trade debtors + Cash = 200,000 + 100,000 + 700,000 = $1,000,000
Current liabilities =  Trade creditors + Bank overdraft = 200,000 + 50,000 = $250,000

Working Capital Ratio = 1,000,000 / 250,000 = 4:1

* Next: Liquidity Ratio Analysis & Example

Author

Kelvin Wong Loke Yuen is an experienced writer with a strong background in finance, specializing in the creation of informative and engaging content on topics such as investment strategies, financial ratio analysis, and more. With years of experience in both financial writing and education, Kelvin is adept at translating complex financial concepts into clear, accessible language for a wide range of audiences. Follow him on: LinkedIn.

Popular posts from this blog

Advantages & Disadvantages of Reducing Balance Method

Advantages of Reducing Balance Method of Depreciation (also known as diminishing balance method, written down value method or reducing installment method): 1. Simplicity and Ease of Use One of the main advantages of the Reducing Balance Method is its simplicity. The method requires only a basic understanding of how to calculate depreciation using the fixed percentage rate applied to the asset's book value. Once the initial cost of the asset and the depreciation rate are determined, it is relatively straightforward to calculate the depreciation expense for each period. This simplicity makes it easy for accountants and businesses to apply this method, particularly when dealing with multiple assets. Moreover, as the method doesn’t require complex estimations of residual values or changes in useful life, businesses can easily calculate depreciation year over year, providing a clear and consistent framework for accounting. This also simplifies financial reporting and compliance with
Read more

Advantages and Disadvantages of Swaps

A swap is a financial derivative instrument that involves the exchange of a series of cash flows between two parties over a specified period. Typically, swaps are used to manage risk, particularly interest rate and currency risk, by converting variable cash flows into fixed ones or vice versa. Swaps can also be employed to align liabilities with revenues, hedge against fluctuations in commodity prices, or manage exchange rate risk. The two most common types of swaps are interest rate swaps and currency swaps, although other variations such as commodity swaps and equity swaps also exist. Swaps have grown in popularity due to their ability to offer more customized solutions compared to traditional financial instruments such as futures, options, or forwards. Despite their advantages, swaps also come with certain risks and drawbacks, which must be carefully considered before entering into such contracts. Below, we explore both the advantages and disadvantages of swaps in more detail. Adv
Read more

How to Calculate Debenture Interest

Debenture is a liability instrument with a fixed rate of interest, and the holders of debenture are considered as creditors of the limited company. Interest on debentures is calculated at a fixed rate of interest on the face value (not on the issue price), and is charged to Profit and Loss Account. Note that such interest must be paid to the debenture holders even if the company is not making a profit or incurring losses. Nature of Debentures Debentures are long-term debt instruments issued by companies, typically with a fixed interest rate and a set maturity date. They are a key tool for companies looking to secure funding without diluting ownership, as debentures do not confer any equity rights to the holders. Instead, debenture holders act as creditors, and their claims on the company are generally subordinate to other types of liabilities such as bank loans or trade payables. Debentures are classified as unsecured or secured. Secured debentures are backed by a specific asset or se
Read more