Current ratio is also known as the working capital ratio is a measure of short term liquidity as well as the overall health of a company and its formula “current assets divided by current liabilities” reflects the company’s ability to make enough cash to pay off its debt obligations once they are due.
What is Current Ratio Formula?
It is the most common ratio to calculate. And even if you ask any new investor, she will tell you about this ratio for sure.
Current Ratio Example
Let’s take a simple Current Ratio example.
Give Company has the following information –
- Sundry Debtors – $40,000
- Inventories – $30,000
- Prepaid Expenses – $5000
- Sundry Creditors – $25000
- Outstanding salaries – $10,000
Find out the CR of giving Company.
Here we have all the information. From the information given, we need to separate out the current assets and the current liabilities.
- Current Assets – Sundry Debtors, Inventories, Prepaid Expenses
- Current Liabilities – Sundry Creditors, Outstanding Salaries
Now, we will find out the total of current assets and current liabilities.
- Total Current Assets = (Sundry Debtors + Inventories + Prepaid Expenses) = ($40,000 + $30,000 + $5000) = $75,000
- Total Current Liabilities = (Sundry Creditors + Outstanding Salaries) = ($25,000 + $10,000) = $35,000.
- CR of Give Company is = Current Assets / Current Liabilities = $75,000 / $35,000 = 2.14.
Colgate Current Ratio Example
Current Ratio is calculated as Current Assets of Colgate divided by Current Liabilities of Colgate.
- CR of Colgate (2010) = 3,730 / 3,728 = 1.00x
- CR of Colgate (2011) = 4,402 / 3,716 = 1.18x
- CR of Colgate (2012) = 4,556 / 3,736 = 1.22x
- CR of Colgate (2013) = 4,822 / 4,470 = 1.08x
For more details, refer to Ratio Analysis excel
The current ratio is calculated because the investor wants to know how liquid a firm is. It is one of the liquidity ratios that are easy to calculate. And it also gives a quick idea about the liquidity of the company.
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To calculate the current ratio, all we need are current assets and current liabilities.
Current assets include assets that can be liquidated within a year from now. If an asset can’t be liquidated within a year, it wouldn’t come under current assets.
It is similar to current liabilities. If the liability can’t be paid off within one year, we can’t consider it under current liabilities.
|Current Assets||Current Liabilities|
|Cash & cash equivalents||Accounts Payable|
|Accounts receivable, or trade receivables||Accrued Compensation|
|Notes receivable maturing within one year||Other accrued expenses|
|Other receivables||Accrued Income Taxes|
|Inventory of raw materials, WIP, finished goods||Short Term notes|
|Office supplies||Current Portion of Long term debt|
Why is this ratio called a liquidity ratio? It’s because it has two components in its – current assets and current liabilities.
Through this ratio, we look at whether the firm has enough current assets to pay off its current liabilities. It means if we liquidate all of the current assets of the company, whether the company would have enough cash to pay off its current liabilities. Therefore, if a company has more current assets and less current liabilities, it is a great position for a company to be in, in terms of liquidity.
As an investor, you don’t know whether the company has enough current assets to pay off its current liabilities. That’s why you need to use this ratio. And once the investor finds out this ratio of the company, she needs to go ahead and look at this ratio of similar companies under the same industry. And then she would check whether the current ratio of the target company is appropriate.
For the current ratio example, if Company A is the investor’s target company, she will first look at the current ratio of Company A (let’s say 3). And then she will look at this ratio of other companies under similar industry to check whether this ratio of the target company in the desired range.
Current Ratio Calculator
You can use the following Current Ratio Calculator
|Current Ratio Formula =||
Current Ratio Formula in Excel (with excel template)
Let us now do the same current ratio example above in Excel. This is very simple. You need to provide the two inputs of Current Assets and Current Liabilities.
You can easily calculate the ratio in the template provided. Now, we will find out the total of current assets and current liabilities.
Now to find the ratio of a given Company, we will use the following formula.
Current Ratio Formula Video
This has been a guide to the Current Ratio Formula, practical Current Ratio example, and Current Ratio calculator along with excel templates. You may also have a look at these articles below to learn more about Financial Analysis –