DECA Retail Merchandising Practice Exam

What type of ratio does the current ratio represent?

1. Profitability ratio

2. Liquidity ratio

3. Leverage ratio

4. Efficiency ratio

The correct answer is: Liquidity ratio

The current ratio is a measure of a company's ability to meet its short-term obligations with its short-term assets, which is why it is classified as a liquidity ratio. This ratio provides insight into the financial health of a business by assessing its capacity to cover its current liabilities, such as accounts payable and accrued expenses, using current assets like cash, inventory, and receivables. A high current ratio indicates that the company has sufficient assets to cover its short-term liabilities, which suggests good financial health and a lower risk of insolvency. Conversely, a low current ratio may signal potential liquidity issues, meaning the company might struggle to meet its obligations. Overall, focusing on liquidity ratios like the current ratio is essential for understanding a business's stability and operational efficiency in the short term.