Working capital ratio

Definition

The working capital ratio, also known as the current ratio, measures a company's ability to pay off its short-term liabilities with its short-term assets. It is calculated by dividing current assets by current liabilities.

5 Must Know Facts For Your Next Test

1. A working capital ratio above 1 indicates that a company has more current assets than current liabilities.
2. A ratio below 1 suggests potential liquidity issues, meaning the company might struggle to meet short-term obligations.
3. This ratio is an important indicator of financial health and operational efficiency.
4. It can be used to compare the liquidity of different companies within the same industry.
5. The ideal working capital ratio varies by industry but generally falls between 1.2 and 2.0.

Review Questions

• What does a working capital ratio above 1 indicate about a company's financial health?
• How do you calculate the working capital ratio?
• Why is the working capital ratio important for assessing a company's liquidity?

Related terms

Current Assets: Assets that are expected to be converted into cash or used up within one year.

Current Liabilities: Obligations that are due to be settled within one year.

Liquidity: A measure of how easily an asset can be converted into cash without affecting its market price.