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Finance Glossary

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Current Ratio

Definition:

"Current Assets/Current Liabilities This is just a measure of wut we got against wut we owe, based on current (short-term) assets and liabilities. Accountants divide assets and liabilities into short and long term sections. It’s a long story as to why they do this and for this discussion it doesn’t really matter. These are both balance sheet items. Say current assets are $10,000,000 and current liabilities are $3,000,000. We like to see 3-1 or better for this ratio. It just means we’re paying our bills faster than we’re collecting them and says a lot about our cash liquidity.

But there’s another thing to look at here—what if our current assets were $100 mil and current liabilities $30 mil? Same ratio but much, much bigger numbers. Imagine the pressure on cash for such a tiny company. What if most of our sales are on credit and something happens so that we can’t collect bills for a while. We could find ourselves in a 1-3 ratio fast with a lot of money involved. This high volume CA/CL situation happens in commodity types of businesses and in banks. So in being a good banker you not only have to look at the ratio itself but the relative size of the gradients relative to what your competitors are doing.

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