ACCA Financial Reporting (F7) Practice Exam

What is the formula for calculating the current ratio?

1. Current Ratio = Current Assets + Current Liabilities

2. Current Ratio = Current Assets - Current Liabilities

3. Current Ratio = Current Assets / Current Liabilities.

4. Current Ratio = Total Assets / Total Liabilities

The correct answer is: Current Ratio = Current Assets / Current Liabilities.

The current ratio is a key financial metric used to assess a company's ability to cover its short-term liabilities with its short-term assets. The correct formula is that the current ratio is calculated by dividing current assets by current liabilities. Current assets include cash, accounts receivable, inventory, and other assets that are expected to be converted into cash or used up within one year. Current liabilities are obligations that the company needs to settle within the same timeframe. By using the specified formula, the current ratio provides insights about liquidity, indicating whether a company has enough resources to pay its debts as they come due. A ratio greater than 1 usually suggests that the company is in a good position to meet its short-term obligations, while a ratio below 1 might be a warning sign of potential liquidity issues. Therefore, the formula correctly reflects this relationship and is essential for financial analysis.