Which formula correctly defines the current ratio and what it measures?

Which formula correctly defines the current ratio and what it measures?

• A. Current liabilities divided by current assets; measures solvency
• B. Net income divided by total assets; measures profitability
• C. Current assets divided by current liabilities; measures short-term liquidity
• D. Quick assets divided by current liabilities; measures liquidity excluding inventory

Answer: (C)

The current ratio is a measure of a company’s ability to meet its short-term obligations with its current assets. It is calculated by dividing current assets by current liabilities. This tells you, in the near term, how many dollars of liquid assets are available to cover each dollar of short-term debt. A ratio above 1 indicates that current assets exceed current liabilities, suggesting better short-term liquidity, though very high values can also imply inefficiency in using assets. The current ratio includes all current assets (including inventory), which is why it’s a broader, more lenient view of liquidity compared with the quick ratio, which excludes inventory to focus on the most liquid assets. The option using net income divided by total assets describes profitability (return on assets), not liquidity. The option using quick assets divided by current liabilities is the quick ratio, which specifically measures liquidity excluding inventory. The current ratio is not a measure of solvency (long-term ability to meet obligations) but of short-term liquidity.

The current ratio is a measure of a company’s ability to meet its short-term obligations with its current assets. It is calculated by dividing current assets by current liabilities. This tells you, in the near term, how many dollars of liquid assets are available to cover each dollar of short-term debt. A ratio above 1 indicates that current assets exceed current liabilities, suggesting better short-term liquidity, though very high values can also imply inefficiency in using assets.

The current ratio includes all current assets (including inventory), which is why it’s a broader, more lenient view of liquidity compared with the quick ratio, which excludes inventory to focus on the most liquid assets. The option using net income divided by total assets describes profitability (return on assets), not liquidity. The option using quick assets divided by current liabilities is the quick ratio, which specifically measures liquidity excluding inventory. The current ratio is not a measure of solvency (long-term ability to meet obligations) but of short-term liquidity.