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    Current Ratio

    The current ratio is found by dividing the firm’s current assets by the firm’s current liabilities. Current liabilities include the current portion of long-term liabilities, for example, interest payments on long-term debt that will become due within the year.



    The current ratio gives us an idea about a firm’s ability to cover its short-term liabilities. That is, over the year we can imagine that the firm will be selling its inventory and collecting accounts receivable and, with the cash it already has in the bank or invested in marketable securities, it will be able to use these proceeds to pay interest on its debt and pay its accounts payable when they become due.

    When a firm’s current ratio goes down, we may look at this trend as potentially signaling that the firm is entering financial distress. As a result, the firm may not be able to cover its short-term liabilities as easily as before. 

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