Chartered Financial Analyst (CFA) Level 1 Practice Exam

What is the formula for calculating the current ratio?

1. Current liabilities / Current assets

2. Total assets / Total liabilities

3. Current assets / Current liabilities

4. Current assets - Current liabilities

The correct answer is: Current assets / Current liabilities

The current ratio is a key liquidity measure that assesses a company's ability to cover its short-term obligations with its short-term assets. The formula for calculating the current ratio is derived from the relationship between current assets and current liabilities, specifically showing how many dollars of current assets are available for each dollar of current liabilities. By using the correct formula, which is current assets divided by current liabilities, you can evaluate whether a business can meet its obligations as they come due. A current ratio greater than 1 indicates that the company has more current assets than current liabilities, suggesting a favorable liquidity position. Conversely, a ratio less than 1 indicates potential liquidity issues. The other options do not represent the current ratio as they focus on different aspects of financial ratios or account balances that do not directly address the company's short-term liquidity position. Option involving total assets and total liabilities, for example, pertains more to solvency rather than liquidity, while subtracting liabilities from assets does not provide a ratio or metric used to gauge liquidity effectively.