The Current Ratio is a very important measure because it’s an indicator of a company’s ability to meet its financial obligations. What exactly is the Current Ratio? It’s a number that is derived by dividing current assets by current liabilities. A current asset is any asset on the balance sheet that’s expected to be realized, or effectively turned into cash, within one year. Examples of current assets are Cash, marketable securities, accounts receivable, inventories, and certain prepaid expenses. Current assets are listed in the current asset section of the balance sheet, which is the very first sub-section listed on the balance sheet.
Current liabilities are all liabilities that are expected to be paid within one year. Examples include accounts payable, accrued expenses, accrued payroll, accrued sales taxes, and the current portion of long-term debt. Current liabilities are listed in the current liabilities section of the balance sheet, which is the very first sub-section of Liabilities and Equity section.
What is a good Current Ratio? As a rule of thumb, most bankers consider the range between 2:1 to 3:1 to be a good. But whether or not it is actually good will depend upon how soon the specific current assets will be realized, especially accounts receivable and inventory. It will also depend on how soon current liabilities will actually have to be paid.
This is why it’s important to have a good business plan model that predicts more precisely when assets will be realized and obligations are expected to be paid. For more information, visit our video library at www.CFOoutsource.com.
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