What is a current ratio?
A current ratio measures a business’ ability to pay short term obligations, which are those payable within a year.
Why is a current ratio important?
A current ratio helps determine the financial viability of a business.
A result of less than 1 can mean that current liabilities can not be paid by current assets. Payment of debts may need to be sourced from different sources, such as the sale of an asset or injection of personal funds. It is important to review as it can be an indicator that a business is trading insolvent, which can have some serious repercussions.
A result of greater than 1 can means that there is an excess for current assets over current liabilities.
Different industries, businesses and even different circumstances can have different minimum set points. For example a business setting aside funds in a bank account for an employee’s long service leave payout requires a higher ratio than one that has no long term employees and does not need to set aside funds.
How to calculate a Current Ratio Formula
Current is calculated by dividing total current assets by total current liabilities.
Current Ratio = Current Liabilities / Current Assets
Current assets including: Cash at bank, Debtors: $160,000
Current liabilities including Creditors, Super Payable, BAS Payable: $90,000
Current Ratio = $160,000 / $90,000 = 1.7778
Hence for every $1 of current debt it is covered by a current asset 1.7778 times.