Final answer:
The current ratio is calculated by dividing a company's current assets by its current liabilities, providing insight into its short-term liquidity. A higher ratio indicates a stronger ability to meet short-term financial obligations, while a lower ratio could suggest liquidity issues.
Step-by-step explanation:
The calculation required to compute the current ratio is Current Assets / Current Liabilities. This financial metric assesses a company's short-term liquidity by measuring its ability to cover short-term obligations with its short-term assets. A higher current ratio indicates a better position to cover current liabilities, while a lower current ratio can signal potential liquidity issues. It is important in understanding the financial strength of a business and is commonly used by creditors and investors to gauge the company's financial health.
To illustrate, if a company has current assets of $150,000 and current liabilities of $75,000, the current ratio would be computed as follows: $150,000 / $75,000 = 2. This ratio suggests that the company has twice as much in current assets as it does in current liabilities, potentially indicating good financial stability in the short term.