Which ratio is useful for monitoring a small service business's health?

• A. Net profit margin
• B. Return on assets (ROA)
• C. Current ratio
• D. Gross margin

Answer: (C)

Focusing on liquidity is key for a small service business. The current ratio directly measures the ability to cover short-term obligations with assets that can quickly be turned into cash, like cash on hand and accounts receivable, compared with what’s due soon, such as short-term debts and payables. This gives you a clear snapshot of near-term financial health and whether you can pay the bills while waiting for client payments.

A ratio above 1 generally indicates you have enough current assets to cover current liabilities, though extremely high values can suggest cash is tied up unnecessarily. By contrast, profitability metrics like net profit margin show how much profit you’re making, but not whether you can meet immediate obligations. Return on assets assesses how efficiently you’re using assets to generate profit, and gross margin focuses on profitability of goods or services before operating costs—both less directly tied to day-to-day cash flow for a service business.