Future Business Leaders of America (FBLA) Agribusiness Practice Test

How does the current ratio indicate a firm's financial health?

1. By showing total profitability

2. By indicating the ability to meet short-term obligations

3. By assessing long-term growth potential

4. By measuring operational efficiency

The correct answer is: By indicating the ability to meet short-term obligations

The current ratio is a financial metric that assesses a company’s liquidity, which is its ability to meet short-term obligations with its short-term assets. This ratio is calculated by dividing current assets by current liabilities. A higher current ratio suggests that the company has a greater ability to cover its short-term liabilities, providing a measure of financial health in terms of liquidity. For example, if a company’s current assets consist of cash, accounts receivable, and inventory, and its current liabilities include accounts payable and short-term debts, the current ratio helps stakeholders understand if the company has enough resources readily available to satisfy its immediate financial commitments. If these assets are significantly greater than the liabilities, it reflects a strong position and confidence in the company’s ability to navigate short-term financial challenges. This focus on short-term obligations differentiates the current ratio from profitability measures, long-term growth potential, or operational efficiency, which are assessed through other financial ratios and indicators.