What does the current ratio compare?

What does the current ratio compare?

• A. Net income to total assets
• B. Cash flow to liabilities
• C. Debt to equity
• D. Current assets to current liabilities

Answer: (D)

Think in terms of liquidity: how easily a company can pay its short-term bills. The current ratio compares current assets—cash, accounts receivable, inventory, and other assets expected to be converted to cash within one year—with current liabilities—obligations due within a year such as accounts payable and short-term debt. You divide current assets by current liabilities to get the ratio. A higher number means more cushion against coming debts; around 1 means assets roughly cover obligations, and below 1 signals potential liquidity problems. For example, current assets of 150,000 and current liabilities of 100,000 yield 1.5, meaning $1.50 in near-term assets for every $1 of near-term liabilities. Other options describe profitability, cash flow alignment, or leverage, which are different concepts and do not specifically measure the ability to cover short-term obligations with near-term assets.

Think in terms of liquidity: how easily a company can pay its short-term bills. The current ratio compares current assets—cash, accounts receivable, inventory, and other assets expected to be converted to cash within one year—with current liabilities—obligations due within a year such as accounts payable and short-term debt. You divide current assets by current liabilities to get the ratio. A higher number means more cushion against coming debts; around 1 means assets roughly cover obligations, and below 1 signals potential liquidity problems. For example, current assets of 150,000 and current liabilities of 100,000 yield 1.5, meaning $1.50 in near-term assets for every $1 of near-term liabilities. Other options describe profitability, cash flow alignment, or leverage, which are different concepts and do not specifically measure the ability to cover short-term obligations with near-term assets.