Final answer:
The current ratio is a financial metric used to assess a company's ability to pay its short-term obligations with its current assets. External users like investors and creditors use this information to determine the company's liquidity and financial health.
Step-by-step explanation:
The current ratio is a liquidity ratio that measures a company's ability to pay short-term obligations with its current assets. To calculate it, you divide the company's current assets by its current liabilities. For example:
Current Ratio = Current Assets / Current Liabilities
If a company has $150,000 in current assets and $100,000 in current liabilities, its current ratio would be:
Current Ratio = $150,000 / $100,000 = 1.5
This means that for every dollar of current liabilities, the company has $1.50 in current assets to cover them.
External users, such as investors, creditors, and analysts, use the current ratio to gauge a company's financial health. A higher ratio indicates more liquidity, suggesting that the company is in a better position to pay its debts. Conversely, a low current ratio might signal potential liquidity problems or that a company is relying too heavily on inventory or other non-cash assets to cover short-term liabilities.