The current ratio helps assess a company's ability to pay off its short term obligations. The ratio aids us in determining a company's ability to cover its current liabilities from its current assets. The higher the ratio, the better the company's ability to cover its short term maturing obligations.
The formula is: Current Assets / Current Liabilities
Example:
Adequate Disclosure, Inc. is looking to invest into Inadequate Disclosure, Inc. One formula the financial analysts are using is the current ratio. The industry average is 1.7. Calculate the Inadequate Disclosure, Inc.’s current ratio.
Should Adequate Disclosure, Inc. invest into Inadequate Disclosure, Inc.?
Current Assets/Current Liabilities = $45,900/$42,600 = 1.07
No, Adequate Disclosure, Inc. should not invest into Inadequate Disclosure, Inc. since the current ratio is lower than the industry average.