How is the current ratio calculated?

The current ratio is a financial metric used to assess a company's short-term liquidity and overall financial health. It is calculated by dividing current assets by current liabilities. This ratio indicates the ability of a company to pay off its short-term obligations with its short-term assets.

Current assets include items that are expected to be converted to cash or used up within one year, such as cash, accounts receivable, and inventory. Current liabilities, on the other hand, are obligations that are due within one year, including accounts payable and short-term debt. A current ratio greater than 1 suggests that the company has more current assets than current liabilities, which is a positive sign of liquidity. Conversely, a ratio less than 1 may indicate potential liquidity issues.

The other choices represent different financial relationships that do not accurately describe the current ratio. Total assets divided by total liabilities provides a measure of the company's leverage, while current liabilities divided by current assets would inversely indicate how much of the current assets are needed to cover liabilities. Lastly, net income divided by total revenue is a measure of profitability rather than liquidity. Understanding the correct calculation of the current ratio is essential for evaluating a company's ability to meet its short-term financial obligations.