Auditing and Attestation- Certified Public Accountant (CPA) Practice Exam -

Which of the following is the primary function of the current ratio?

1. To measure profitability over a period of time

2. To assess the financial flexibility of a firm

3. To determine the liquidity position of a firm

4. To evaluate the operational efficiency of a firm

The correct answer is: To determine the liquidity position of a firm

The primary function of the current ratio is to determine the liquidity position of a firm. The current ratio is calculated by dividing a company's current assets by its current liabilities. This ratio provides insights into a company's ability to meet its short-term obligations and indicates whether the company has enough resources to cover its debts that are due within the next year. A higher current ratio suggests better liquidity, meaning the company is in a stronger position to pay off its short-term liabilities with its short-term assets. This is crucial for stakeholders, including investors and creditors, who are interested in understanding the company's short-term financial health. While the other options discuss important aspects of financial analysis—such as profitability, financial flexibility, and operational efficiency—none of those directly relate to the primary function of the current ratio. Instead, they focus on broader analyses of the firm's performance or strategic position rather than specifically measuring liquidity. The current ratio serves strictly to assess how well a company can meet its immediate financial obligations.