The current ratio is an inappropriate relationship to use or rely on in small business. The ratio is best suited for large publicly traded organizations. This article explains the basic formula for the current ratio, how to identify the ratio in reading financial statements, its purpose and the many drawbacks for its use with small business. Finally some alternative measurement tools are presented for use in small business evaluation instead of the current ratio.
Basic Formula – Current Ratio
One of the primary business requirements is the payment of bills (accounts payable) and other operational costs (labor, taxes, facilities, office expenses etc.) on a regular basis (weekly and monthly). These costs are commonly referred to as current liabilities (due within one accounting cycle – a month, quarter or a year). Current assets, specifically cash, are used to fulfill the payment of current liabilities. Naturally the more current assets in existence, the easier and the likelier the current liabilities will get paid in a timely fashion.
The formula is relatively simple and easy to understand: