How is the current ratio calculated?

The current ratio is a key financial metric used to assess a company's ability to pay its short-term obligations. It is calculated by dividing current assets by current liabilities, which provides insight into the liquidity position of the business.

Current assets are assets that are expected to be converted into cash or used within one year, such as cash, accounts receivable, and inventory. Current liabilities, on the other hand, are obligations that are due within the same time frame, including accounts payable and short-term debt.

By expressing current assets in relation to current liabilities, the current ratio indicates whether a company has enough resources to cover its short-term debts. A ratio above 1 typically suggests that the company is in a good position to meet its obligations, while a ratio below 1 may signal potential liquidity issues.

This calculation is critical for investors and creditors when evaluating the financial health and stability of a company, making the understanding of the current ratio essential for financial analysis and modeling.