To determine the correct answer for the current ratio, we first need to understand what the current ratio is and how to calculate it. What is the Current Ratio? The current ratio is a financial metric used to evaluate a company's ability to pay its short-term liabilities with its short-term assets. It is calculated using the following formula: [ \text{Current Ratio} = \frac{\text{Current Assets}}{\text{Current Liabilities}} ]

• Current Assets are assets that are expected to be converted into cash or used up within one year. This includes cash, accounts receivable, inventory, and other short-term assets.
• Current Liabilities are obligations that the company needs to settle within one year, such as accounts payable, short-term loans, and other short-term debts.

Step-by-Step Calculation

1. Identify Current Assets and Current Liabilities:
2. Let's assume the current assets are $500,000 and the current liabilities are $100,000 (these numbers are hypothetical since the actual values were not provided in the question).
3. Apply the Formula: [ \text{Current Ratio} = \frac{500,000}{100,000} = 5 ]
4. Express the Ratio:
5. The current ratio can be expressed as 5:1, meaning for every dollar of current liabilities, the company has $5 in current assets.

Why the Correct Option is C (5:1) Given the calculation above, the current ratio is 5:1, which corresponds to option C. This indicates a strong liquidity position, suggesting that the company is well-equipped to cover its short-term obligations. Why the Other Options are Incorrect

• Option A (4:1): This would imply that the current assets are $400,000 if current liabilities are $100,000. This is lower than the calculated current assets of $500,000, making this option incorrect.
• Option B (4.5:1): This would suggest current assets of $450,000. Again, this is less than the calculated current assets of $500,000, so this option is also incorrect.
• Option D (25.5:1): This would imply current assets of $2,550,000 if current liabilities are $100,000. This is significantly higher than the calculated current assets, making this option unrealistic and incorrect.

Common Pitfalls

• Misunderstanding Current Assets and Liabilities: Students often confuse current assets with total assets or current liabilities with total liabilities. It’s crucial to focus only on the short-term components.
• Calculation Errors: Simple arithmetic mistakes can lead to incorrect ratios. Always double-check your calculations.
• Interpreting the Ratio: A high current ratio (like 25.5:1) might seem good, but it could also indicate inefficiency in using assets. A ratio of around 1.5 to 3 is generally considered healthy.

Revision Summary

• The current ratio measures a company's ability to pay short-term liabilities with short-term assets.
• It is calculated using the formula: Current Ratio = Current Assets / Current Liabilities.
• The correct answer for the current ratio, based on the hypothetical values, is 5:1 (Option C).
• Always ensure to differentiate between current and total assets/liabilities to avoid calculation errors.

By understanding these concepts and practicing calculations, you can confidently tackle questions related to the current ratio in your exams.