How is the current ratio calculated?

How is the current ratio calculated?

• A. Current Assets / Current Liabilities
• B. Total Assets / Total Liabilities
• C. Current Liabilities / Current Assets
• D. Net Income / Tax

Answer: (A)

The current ratio measures short-term liquidity by comparing what a business can turn into cash in the near term with what it must pay in the near term. It is calculated by dividing current assets by current liabilities. Current assets are items expected to be converted to cash or used up within a year (like cash, accounts receivable, and inventory), while current liabilities are obligations due within a year (such as accounts payable, short-term debt, and accrued expenses). Interpreting the ratio, more current assets per dollar of current liabilities means a stronger ability to cover upcoming obligations, with higher values indicating better liquidity. A ratio around 1 or above is typically considered acceptable, though the ideal level varies by industry. The other options don’t measure liquidity in the same way: total assets divided by total liabilities gives a broader solvency measure, not the short-term liquidity of the balance sheet; current liabilities divided by current assets is the inverse of the current ratio and would indicate how leveraged the short-term side is; net income divided by tax is an income statement metric, not a balance sheet liquidity ratio.

The current ratio measures short-term liquidity by comparing what a business can turn into cash in the near term with what it must pay in the near term. It is calculated by dividing current assets by current liabilities. Current assets are items expected to be converted to cash or used up within a year (like cash, accounts receivable, and inventory), while current liabilities are obligations due within a year (such as accounts payable, short-term debt, and accrued expenses). Interpreting the ratio, more current assets per dollar of current liabilities means a stronger ability to cover upcoming obligations, with higher values indicating better liquidity. A ratio around 1 or above is typically considered acceptable, though the ideal level varies by industry.

The other options don’t measure liquidity in the same way: total assets divided by total liabilities gives a broader solvency measure, not the short-term liquidity of the balance sheet; current liabilities divided by current assets is the inverse of the current ratio and would indicate how leveraged the short-term side is; net income divided by tax is an income statement metric, not a balance sheet liquidity ratio.