ACCA Performance Management (F5) Certification Practice Exam

What is the correct formula for the current ratio?

1. Current asset - current liability

2. Current asset / Current liability

3. Current liability / Current asset

4. Current asset + Current liability

The correct answer is: Current asset / Current liability

The current ratio is a key financial metric used to evaluate a company's ability to pay its short-term obligations with its short-term assets. The correct formula for calculating the current ratio is to divide current assets by current liabilities. This ratio provides insight into the liquidity of a business, indicating how well the company can cover its short-term debts with assets that are expected to be converted into cash or used up within a year. A higher current ratio suggests that the company is in a stronger liquidity position, whereas a lower ratio may indicate potential financial difficulties. The other formulas—subtracting current liabilities from current assets, taking the ratio of current liabilities to current assets, or adding current liabilities to current assets—do not represent a valid method for assessing liquidity and do not provide useful information about the company’s short-term financial health. Thus, the division of current assets by current liabilities captures the essence of the current ratio effectively.