'Current ratio' is one of the important indicators to look at when looking at financial statements and is a concept that you should know.

What is the Current Ratio?

Current Ratio (Quick ratio)is one of the indicators that evaluates a company's short-term debt repayment ability, meaning 'the ratio of current assets to current liabilities'. At this time, current assets refer to assets that can be immediately converted into cash, such as cash and cash equivalents, accounts receivable, and short-term financial products, and current liabilities refer to liabilities that must be repaid within one year.

Simply put, the current ratio is an indicator that shows how quickly a company can repay its short-term debt using its cash-like assets and accounts receivable. Generally, a current ratio of 100% or more is considered stable, and a ratio of 70% or less is considered likely to face difficulties in repaying short-term debt.

Therefore, for successful investment, it is important to analyze the company's financial statements, including its current ratio, to determine its short-term debt repayment ability and stability. In addition, the current ratio provides useful information in formulating the company's financing and operation plans.

Importance of the Current Ratio: Why should I know it?

The reason why investors should know the current ratio is that it is a very important indicator to judge a company's short-term liquidity and creditworthiness.

For example, the lower the company's current ratio, the more likely it is to face difficulties in repaying short-term debt, which can lead to a decrease in the company's creditworthiness and an increase in its cost of financing. Conversely, a higher current ratio indicates that the company's short-term debt repayment ability is excellent, which acts as a factor that increases the trust and stability of investors in the company.

In particular, in stock investment, since a company's financial condition greatly affects the stock price, it is good to actively use financial indicators, including the current ratio, to make investment decisions. This can minimize investment risk and maximize profits.

How to calculate the Current Ratio

The current ratio is calculated using the following formula.

• Current Ratio = (Current Assets / Current Liabilities) x 100

Here, 'Current Assets'refers to assets that can be immediately converted to cash, such as cash and cash equivalents, short-term financial products, and accounts receivable, while 'Current Liabilities'refers to liabilities that must be repaid within one year.

At this time, a modified current ratio can be calculated by multiplying the denominator and numerator by the total assets. This is used for comparative purposes because the composition of current assets and current liabilities varies depending on the industry.

This calculated current ratio is generally considered good if it is 100% or more, and bad if it is 70% or less. However, this is not an absolute standard and can be applied differently depending on the industry or characteristics of the company.

Current Ratio and a Company's Financial Health

The current ratio is one of the indicators to evaluate a company's short-term debt repayment ability, and the higher the ratio, the better the company's financial health is considered. The reason for this is as follows.

• Since current assets are assets that a company can convert to cash in the short term, a high current ratio means that the company is less likely to face difficulties in repaying short-term debt.
• Current assets are one of the indicators that show a company's liquidity. That is, a company with a high current ratio has abundant liquidity, so it can be said that it has a high ability to cope with economic uncertainty.
• Current assets also play an important role in increasing a company's creditworthiness. When financial institutions evaluate loans, they consider a company's financial indicators, including the current ratio. Therefore, a company with a high current ratio can obtain advantageous conditions, such as interest rates and loan limits.

Limitations and Precautions of the Current Ratio

The current ratio is a useful indicator for evaluating a company's short-term debt repayment ability, but it has some limitations and precautions.

• The current ratio does not include inventory or prepaid expenses, so a high current ratio does not necessarily mean that the company's actual liquidity is high. This is because such assets can take time to convert to cash or their value can fluctuate.
• The appropriate level of the current ratio can vary depending on the industry. For example, in the manufacturing industry, where the proportion of raw material purchases is high, even if the current ratio is relatively low, it can be considered that the company has sufficient debt repayment ability. However, in the distribution industry, a high current ratio is required for stable management.
• The current ratio may be distorted depending on the method of evaluating current assets and current liabilities. For example, if current assets are inflated or current liabilities are reduced, the current ratio may appear higher than it actually is, so care should be taken.

Comparison with Other Financial Ratios: The Relative Importance of the Current Ratio

The current ratio is useful for evaluating a company's short-term debt repayment ability, but it should be considered in conjunction with other financial ratios.

For example, the debt-to-equity ratio is useful for evaluating a company's long-term debt repayment ability, and the times interest earned ratio is useful for evaluating a company's ability to pay interest expense. Accounts receivable turnover is useful for determining the collection period of accounts receivable, as it is one of the most important items among current assets.

Therefore, for successful investment, it is important to consider various financial ratios, such as those mentioned above, comprehensively to evaluate a company's financial condition and business performance.

Conclusion

It is one of the indicators that determines the stability of a company, so please keep it in mind and use it effectively.