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How is the current ratio calculated?
ATotal current assets minus total current liabilities
BTotal current liabilities over total current assets
CTotal current assets over total current liabilities
DTotal current assets over total assets of the firm
Answer & Solution
Correct answer: C. Total current assets over total current liabilities
1. The current ratio is the ratio of total current assets to total current liabilities.
2. Total current assets go on top as the numerator, and total current liabilities go underneath as the denominator.
3. A higher value means more current assets stand behind each dollar of short-term claims, so the firm looks more liquid.
4. Subtracting the two instead of dividing gives net working capital, a dollar amount rather than a ratio.
5. Inverting the fraction would make a strong firm look weak, since the number would fall as current assets rose.
_Source: OpenStax Introduction to Business (CC BY 4.0), Ch 14 "Using Financial Information and Accounting", section 14.7 Analyzing Financial Statements_
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