“Change your thoughts and you change your world.” Norman Vincent Peale
The first ratio we’ll look at is the Current Ratio. This ratio measures the amount of current assets in a company that is available to pay for its current liabilities.
If you recall from part 1, current assets are the type that can be converted into cash within a year or less. Current liabilities are those that will be due for payment within a year.
A very simplified example of this ratio is as follows: Suppose that you have $1,000 in the bank and that you also have a $500 credit card bill that’s due this month. If we wanted to calculate your current ratio, in other words, determine how much in current assets ($1,000) you have to cover your current liabilities ($500), all we would need to do is divide $1,000 by $500 = 2.
Your current ratio is 2, which means that you have two times more current assets than current liabilities. This is a good sign of liquidity. If your ratio is 1, it would indicate that you have exactly the same amount in current assets as you do in current liabilities.
A ratio of 1 or less is a worrisome ratio for any company to have. It’s a sign of liquidity problems that may continue to deteriorate in the coming periods. The standard ratio is 2:1, which indicates that there are twice as many current assets to pay for current liabilities.
To reiterate, the formula to calculate the current ratio of any company is:
Current Ratio = Current Assets / Current Liabilities
Do you have any questions for me? Need further clarification? Feel free to post your questions below, and I’ll be sure to respond promptly.
If you would like to receive free content and exam tips via email, please subscribe using the form below. I wouldn’t want you to miss out on these golden nuggets.
Hi, I’m Nathan Liao (aka the CMA Coach)! For the last 10 years, over 82,000 accounting and finance pros came knocking at my door seeking guidance and help. If you’re also aiming to conquer the CMA exam on your very first try—without wasting away time or money—you’ve found your ultimate guide. Dive in deeper to discover more about me and the dedicated team that powers CMA Exam Academy. Click here and let’s embark on this journey together!