How is the current ratio calculated?

The current ratio is a key financial metric used to evaluate a company's ability to pay its short-term obligations with its short-term assets. It provides insight into the liquidity position of a business.

The correct method of calculating the current ratio involves taking current assets and dividing them by current liabilities. Current assets typically include cash, accounts receivable, inventory, and other assets expected to be converted into cash or used up within one year. Current liabilities include obligations such as accounts payable, short-term loans, and other debts due within the same period.

By using the ratio of current assets to current liabilities, one can assess whether a company has sufficient short-term resources to cover its short-term liabilities. A ratio greater than one suggests that the company has more current assets than current liabilities, indicating better financial stability and liquidity. Conversely, a ratio less than one may suggest potential liquidity issues.

Thus, the division of current assets by current liabilities accurately represents the financial health regarding a company's ability to meet its short-term financial obligations.