What financial ratio measures a company's ability to pay short-term obligations?

What financial ratio measures a company's ability to pay short-term obligations?

• A. Debt-to-equity ratio
• B. Current ratio
• C. Return on equity
• D. Price-to-earnings ratio

Answer: (B)

The current ratio is a financial metric used to assess a company's liquidity, specifically its ability to meet short-term obligations. It is calculated by dividing a company's current assets by its current liabilities. Current assets include cash, accounts receivable, and inventory, while current liabilities encompass debts and obligations due within one year. A higher current ratio indicates that a company has more current assets relative to its current liabilities, suggesting a stronger financial position to cover short-term debts. Conversely, a ratio less than one might indicate potential liquidity problems, as it suggests that the company does not have enough short-term assets to meet its short-term obligations. This focus on short-term financial health distinguishes the current ratio from other ratios like the debt-to-equity ratio, which reflects long-term financial leverage, or return on equity, which gauges profitability relative to shareholders' equity. The price-to-earnings ratio, meanwhile, evaluates the company’s current share price relative to its earnings per share, which also does not directly address short-term liquidity. In summary, the current ratio is specifically designed to measure the capacity of a company to fulfill its short-term financial commitments, making it the appropriate choice in this context.

The current ratio is a financial metric used to assess a company's liquidity, specifically its ability to meet short-term obligations. It is calculated by dividing a company's current assets by its current liabilities. Current assets include cash, accounts receivable, and inventory, while current liabilities encompass debts and obligations due within one year.

A higher current ratio indicates that a company has more current assets relative to its current liabilities, suggesting a stronger financial position to cover short-term debts. Conversely, a ratio less than one might indicate potential liquidity problems, as it suggests that the company does not have enough short-term assets to meet its short-term obligations.

This focus on short-term financial health distinguishes the current ratio from other ratios like the debt-to-equity ratio, which reflects long-term financial leverage, or return on equity, which gauges profitability relative to shareholders' equity. The price-to-earnings ratio, meanwhile, evaluates the company’s current share price relative to its earnings per share, which also does not directly address short-term liquidity.

In summary, the current ratio is specifically designed to measure the capacity of a company to fulfill its short-term financial commitments, making it the appropriate choice in this context.