The current ratio, also known as the liquidity ratio, is an important number used in financial analysis to determine the short-term financial health of a company. This ratio is especially important for investors, creditors, and company management, as it indicates the company's ability to meet its short-term debts.
The current ratio is calculated by dividing a company's current assets by its current liabilities. Current assets are the company's assets that can be converted into cash within a year, including cash, stocks, and accounts receivable. Current liabilities are the company's debts that must be paid within a year, including short-term loans, bills, and wages payable.
Let's illustrate this with an example. Suppose Company A has current assets worth 500,000 euros and current liabilities of 400,000 euros. The current ratio would then be 500,000/400,000, resulting in a current ratio of 1.25.
A current ratio of more than 1 suggests that a company has sufficient resources to meet its short-term debts, while a ratio of less than 1 may indicate that a company may have difficulty paying its debts. However, a too high current ratio may indicate that a company is not using its assets efficiently to generate growth.
Although the current ratio is a useful indicator, it should be used in conjunction with other financial ratios and measures to get a complete picture of a company's financial health. It is also important to compare a company's current ratio with that of other companies in the same sector, as what is considered a "healthy" ratio can vary between different industries.