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
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