Thursday, August 23, 2007

How to use the Current Ratio

Let's take a moment to discuss the Current Ratio, also known as the Working Capital Ratio. It's pretty simple to figure out from the name, that it's a ratio designed to analyze a company's ability to meet it's short term (current!) obligations. To find your ratio, go grab a balance sheet and find the current assets. Then divide them by the current liabilities.

That's your ratio... but what does it mean?

Obviously, you want there to be more assets than liabilities. If your company has a current ratio of less than 1, you should seriously consider selling that stock immediately. If the ratio is between 1.5 and 2.5, your stock is probably in good shape.

The Current Ratio is a good weeding tool. Use it to clear away a lot of the messy stocks first, and then you can look for your remaining picks. It also a useful and EASY tool for comparing stocks. If you have two nearly identical stocks, but one of them has a higher current ratio, that would be the stock you'd want to pick.

One thing to watch out for are stocks with really high ratios. Stocks with super high ratios may be making inefficient use of their assets.

Thanks for stopping by my blog. -----Sincerely, Trevor Stasik.

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