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Current ratio is balance-sheet financial performance measure of company liquidity. Current ratio indicates a company’s ability to meet short-term debt obligations. It is the most widely used test of liquidity of a business and measures the ability of a business to repay its debts over the period of next 12 months.
Current ratio is calculated using the following formula:
Current Ratio = Current Assets/Current Liabilities
Both the above figures can be obtained from the balance sheet of the business. Current assets are the assets of a business expected to be converted to cash or used up in next 12 months or within the normal operating cycle of the business. Current liabilities on the other hand are the obligations of a business which need to be settled within next 12 months or within the normal operating cycle.
Current ratio below 1 shows critical liquidity problems because it means that total current liabilities exceed total current assets. General rule is that higher the current ratio better it is but there is a limit to this. Abnormally high value of current ratio may indicate existence of idle or underutilized resources in the company.
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