How do you calculate the current ratio and what does it indicate?

• A. Current ratio = current liabilities / current assets; indicates long-term solvency.
• B. Current ratio = total assets / total liabilities; indicates overall leverage.
• C. Current ratio = current assets - current liabilities; indicates working capital level.
• D. Current ratio = current assets / current liabilities; indicates short-term liquidity.

Answer: (D)

The current ratio measures short-term liquidity by showing how many dollars of current assets are available to cover each dollar of current liabilities. To calculate it, divide current assets by current liabilities. For example, if current assets are 120,000 and current liabilities are 60,000, the ratio is 2.0, meaning the company has twice as many current assets as short-term obligations and should be able to meet those obligations easily. In general, higher values indicate stronger liquidity, though extremely high ratios can signal cash or inventory may be tied up rather than invested.

The other formulations don’t reflect the standard current ratio: dividing current liabilities by current assets gives the inverse of the ratio; using total assets and total liabilities measures overall solvency or leverage rather than short-term liquidity; and subtracting current liabilities from current assets yields working capital in dollar terms, not a ratio.