Question

Please help with calculation

Current ratio: Current assets\Current liabilities The firm’s ability to meet its current financial liabilities

https://ir.americanexpress.com/AsReported/Index

Answer 1

Current Ratio:

The current ratio is an accounting measure that tells you if a company can pay such short-term obligations as payroll and rent for the year. A good metric for investors to use when analyzing securities, the current ratio is a relatively simple calculation: current assets divided by current liabilities.

The current ratio is a measure of how likely a company is to be able to pay its debts in the short term. Short-term debts are generally money owed within a year. The current ratio essentially indicates liquidity. Below 1 means the company will not be able to pay its debts within the year.

The formula for calculating the current ratio is:

Current Ratio = Current Assets/Current Liabilities

Example of the Current Ratio Formula:

If a business holds:

• Cash = $15 million
• Marketable securities = $20 million
• Inventory = $25 million
• Short-term debt = $15 million
• Accounts payables = $15 million

Current assets = 15 + 20 + 25 = 60 million

Current liabilities = 15 + 15 = 30 million

Current ratio = 60 million / 30 million = 2.0x

The business currently has a current ratio of 2, meaning it can easily settle each dollar on loan or accounts payable twice. A rate of more than 1 suggests financial well-being for the company. There is no upper-end on what is “too much,” as it can be very dependent on the industry, however, a very high current ratio may indicate that a company is leaving excess cash unused rather than investing in growing its business.

Analysis:

The current ratio does help the company investor and creditors example bank to comply with the financial state of the firm. This is to check out whether they can able to clear off their short term debts or not. The ratio expresses the current rate of firm assets and the liabilities owed by the company.

The higher ratio of the company is more preferable rather than a lower current ratio of the firm. It is because of the higher ratio results in getting the best financial state of the company. It means the company can quickly pay off the debts.

However, if the company needs to sell out its fixed assets for clearing short term debts, it simply means the firm is not making enough from the current operations of the company. Meanwhile, It is going in the loss.

Let me show you by example:

Example:

Charlie’s balance sheet he reported $100,000 of current liabilities and only $25,000 of current assets. Charlie’s current ratio would be calculated like this:

Current Ratio = Current Assets/Current Liabilities

Current Ratio = 25000/100000

Current Ratio = .25

It means the business of charlie is at higher risks. Because the ratio of charlie business is only .25% to clear off his debts by selling out the current assets, the bank more likely to prefer the current ratio of 1 or 2 so, that the liabilities should be covered by selling of the assets and meanwhile, charlie not approved for the loan.

Conclusion:

The current ratio is the liquidity calculation for any business. It often used for measuring the financial position of the company. You can check out the example above where we showed the condition of charlie, and he has only .25% chance to pay off his debts. In this case, the bank will not pass your loan.

Therefore, It is essential to make a better ratio to ensure that your loan should not be rejected.

Why Use the Current Ratio Formula?

This current ratio is classed with several other financial metrics known as liquidity ratios. These ratios all assess the operations of a company in terms of how financially solid the company is in relation to its outstanding debt. Knowing the current ratio is vital in decision-making for investors, creditors, and suppliers of a company. The current ratio is an important tool in assessing the viability of their business interest.

How to Use the Current Ratio:

It is easy to calculate the current ratio, but it takes a bit more nuance to employ it as a method of stock analysis. There isn’t a specific number you are looking for when calculating the current ratio. However, there are some basic inferences you can take from the current ratio once you’ve calculated it.

For instance, if the current ratio is less than 1, this means that the company’s outstanding debts owed within a year are higher than the current assets the company holds. This is generally not a good sign, as it could mean the company is in danger of becoming delinquent on its payments, which is never good. Keep in mind, though, that the company may simply be awaiting a big influx of cash, whether in the form of a new investment or payment for a big sale of the product it manufactures.

A particularly high current ratio also may not be a good sign. What makes for a high current ratio varies from industry to industry (restaurants tend to have lower current ratios than technology companies). If the current ratio is close to five, for instance, that means the company has five times as much cash on hand as its current debts. While the company is obviously not in danger of going bankrupt, it has a huge amount of cash or easily convertible assets simply sitting in its coffers. A company could reinvest that money. It could hire more employees, build a new facility or expand its product line. The fact that it is not doing so could be signs of mismanagement or inefficiency.

Current Ratio Formula – What are Current Assets?

Current assets are resources that can quickly be converted into cash within a year’s time or less. They include the following:

• Cash – Legal tender bills, coins, undeposited checks from customers, checking and savings accounts, petty cash
• Cash equivalents: cash equivalents are the most liquid of all assets on the balance sheet. Cash equivalents include money market securities, Bankers Acceptances, Treasury bills, commercial paper, and other money market instruments. – Corporate or government securities with 90 days or less maturity
• Marketable securities: Marketable securities are unrestricted short-term financial instruments that are issued either for equity securities or for debt securities of a publicly listed company. The issuing company creates these instruments for the express purpose of raising funds to further finance business activities and expansion. – Common stock, preferred stock, government and corporate bonds with a maturity date of 1 year or less
• Accounts Receivable: Accounts Receivable (AR) represents the credit sales of a business, which are not yet fully paid by its customers, a current asset on the balance sheet. Companies allow their clients to pay at a reasonable, extended period of time, provided that the terms are agreed upon. – Money owed to the company by customers and that is due within a year – This net value should be after deducting an allowance for doubtful accounts (bad credit)
• Notes Receivable :Notes receivable are written promissory notes that give the holder, or bearer, the right to receive the amount outlined in an agreement. Promissory notes are a written promise to pay cash to another party on or before a specified future date. If the note receivable is due within a year, then it is treated as a current asset on the balance sheet. – Debt that is maturing within a year
• Other receivables – Insurance claims, employee cash advances, income tax refunds
• Inventory:Inventory is a current asset account found on the balance sheet, consisting of all raw materials, work-in-progress, and finished goods that a company has accumulated. It is often deemed the most illiquid of all current assets - thus, it is excluded from the numerator in the quick ratio calculation. – Raw materials, work-in-process, finished goods, manufacturing/packaging supplies
• Office supplies – Office resources such as paper, pens, and equipment expected to be consumed within a year
• Prepaid expenses:Prepaid expenses represent expenditures that have not yet been recorded by a company as an expense, but have been paid in advance. In other words, prepaid expenses are expenditures paid in one accounting period, but that will not be recognized until a later accounting period. – Unexpired insurance premiums, advance payments on future purchases

Current Ratio Formula – What are Current Liabilities?

Current liabilities are business obligations owed to suppliers and creditors, and other payments that are due within a year’s time. This includes:

• Notes payable:Notes Payable are written agreements (promissory notes) in which one party agrees to pay the other party a certain amount of cash. Alternatively put, a note payable is a loan between two parties. See required elements of a note and examples. – Interest and the principal portion of loans that will become due within one year
• Accounts payable:Accounts payable is a liability incurred when an organization receives goods or services from its suppliers on credit. Accounts payable are expected to be paid off within a year’s time, or within one operating cycle (whichever is longer).  AP is considered one of the most liquid forms of current liabilities or Trade payable – Credit resulting from the purchase of merchandise, raw materials, supplies, or usage of services and utilities
• Accrued expenses:Accrued expenses are expenses that are recognized even though cash has not been paid. These expenses are usually paired up against revenue via the the matching principle from GAAP (Generally Accepted Accounting Principles). – Payroll taxes payable, income taxes payable, interest payable, and anything else that has been accrued AccrualIn financial accounting or accrual accounting, accruals refer to the recording of revenues that a company may earn, but has yet to receive, or the expenses that it may incur on credit, but has yet to pay. In simple terms, it is the adjustment of accumulated debts and credits. for but an invoice is not received
• Deferred revenue:Deferred revenue is generated when a company receives payment for goods and/or services that it has not yet earned. In accrual accounting, revenue is only recognized when it is earned. If a customer pays for good/services in advance, the company does not record any revenue on its income statement and instead records a – Revenue that the company has been paid for that will be earned in the future when the company satisfies revenue recognition Revenue recognition is an accounting principle that outlines the specific conditions under which revenue is recognized. In theory, there is a wide range of potential points at which revenue can be recognized. This guide addresses recognition principles for both IFRS and U.S. GAAP. requirements.