ACCA Financial Management (F9) Certification Practice Exam

What does the current ratio test?

1. The company's overall profitability

2. The liquidity of a company

3. The company’s debt ratio

4. The efficiency of asset utilization

The correct answer is: The liquidity of a company

The current ratio is a financial metric that specifically measures a company's liquidity, which is its ability to meet short-term obligations using its current assets. The formula for the current ratio is current assets divided by current liabilities. A higher current ratio indicates a stronger liquidity position, suggesting that the company can cover its short-term debts more comfortably. Liquidity is crucial for any business, as it ensures that the company can pay off its immediate liabilities without having to sell long-term assets or secure additional financing. This ratio is especially important for assessing the financial health of a company, particularly in times of economic uncertainty or cash flow challenges. The other options, while related to financial health, do not pertain specifically to what the current ratio measures. Overall profitability looks at the company's ability to generate profit over time rather than its ability to address immediate obligations. The company’s debt ratio focuses on the proportion of debt relative to equity, providing insight into financial leverage rather than liquidity. Finally, efficiency of asset utilization assesses how effectively a company uses its assets to generate revenue, which is distinct from liquidity metrics. Therefore, the correct understanding of the current ratio is that it tests a company's liquidity.