What is Current Ratio and Why Does It Matter?

Running out of cash can be a frightening experience.

It is one thing when you are in a restaurant, and you leave your wallet at home. However, it can be quite stressful to realize you have a potential cash flow problem coming down the pike. By exercising financial discipline, you can avoid some everyday stresses.

Many Americans have not put enough savings

By exercising financial discipline, you can avoid some everyday stresses. Having a large emergency fund when unforeseen events happen can soften the blow of sudden but necessary expenses. Having liquidity has become even more apparent during the pandemic.

Personal Net Worth As A Key Benchmark

Net worth is a great way to review your personal financial data accounts at a point in time. It is calculated using your total assets: what you own less total liabilities, or what you owe. Hopefully, what you own is over what you owe. Using data from your net worth, you can analyze many different key personal financial ratios to develop better habits.

Liquid Net Worth As A More Realistic View

Liquid net worth is an even better and more realistic benchmark because it focuses on your assets’ liquid nature. That means those assets that can be quickly converted into cash with little or no loss of value. Although net worth remains a helpful gauge, it doesn’t differentiate your assets from their liquidating value.

What Is The Current Ratio?

When measuring your current ratio, your focus is on existing assets. You can convert into cash within a year and current liabilities due within the year. The current ratio is sometimes referred to as the working capital ratio.

Who Evaluates Your Current Ratio

This ratio is essential to avoid money shortfalls but may highlight your liquid position to maximize your business growth or family wealth.  Financial advisors use your data to help you develop your goals and strategies to achieve your financial plan.

The Current Ratio Definition

The current ratio relates current assets to current liabilities and is easy to calculate. It helps you to understand your liquidity position within the short term period of one year.  Liquidity refers to the ability to convert your assets into cash with little or no loss of value.

Not All Assets Are Equal

A current ratio measures the household’s ability to liquidate those assets to meet their short-term obligations without additional borrowing.  Cash inflows and cash outflows are often a trade-off between having liquidity and using your surplus cash for growth.

Current Ratio Formula = Short term Assets/ Short Term Liabilities.

Current liabilities reflect the debt payments owed in the current year. That would be your monthly credit card balances, and other debt payments owed that year. A ratio of one or higher indicates you have more short term assets than debt, a sign of good financial health.

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