What Is Current Ratio in Accounting?
Financial accounting is an important task associated with running a business. If you don’t know how much money you spend and how much you generate, you won’t be able to optimize your business’s operations, resulting in lower profits. But there are a number of metrics used to measure a business’s financial health, one of which is current ratio. As a business owner, you should familiarize yourself with current ratio so that you can effectively use this metric in your financial accounting efforts.
Current Ratio Explained
Current ratio is a financial metric used to determine if a business has the adequate amount of money and resources needed to cover its short-term expenses. It’s calculated by taking a business’s current assets and dividing it by the business’s current liabilities. If your business has $500,000 in current assets and $300,000 in current liabilities, its current ratio would be 1.66.
A current ratio above 1.0 indicates that your business’s assets are worth more than the cost of its liabilities. Of course, that’s a good thing. If your business’s liabilities are higher than its assets, your business may spend more money than what it earns. In this regard, current ratio is primarily used to measure a business’s liquidity.
Current Ratio Vs Quick Ratio
Current ratio is often confused with quick ratio. Both of these financial metrics reveal a business’s liquidity by comparing its assets with its liabilities. However, that doesn’t necessarily mean they are the same. The difference between current ratio and quick ratio is that the former takes into account all assets, whereas the latter only takes into account highly liquid assets that can be easily converted to cash in a short period of time. Examples of assets used in the quick ratio formula include cash and accounts receivables.
How to Improve Your Business’s Current Ratio
There are several steps you can take to improve your business’s current ratio. First, try to keep your liabilities to a minimum. In other words, avoid taking out loans or using credit cards to fund your business. Second, work to increase your business’s current assets. With more assets, you’ll achieve a higher current ratio. There are countless ways to increase assets, such as exploring new markets or releasing new products or services. With a little work, you can improve your business’s current ratio, allowing for greater liquidity.
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