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What Is the Current Ratio?

• How It Works
• Formula and Calculation

Using the Current Ratio

• Other Liquidity Ratios
• Limitations

The Bottom Line

• Corporate Finance
• Financial Ratios

Current Ratio Explained With Formula and Examples

• Guide to Financial Ratios
• Measures of a Company's Financial Health
• Financial Risk Ratios to Measure Risk
• Profitability Ratios
• Liquidity Ratios
• Solvency Ratios
• Solvency Ratios vs. Liquidity Ratios
• Multiples Approach
• Return on Assets (ROA)
• Return on Equity (ROE)
• Return on Investment (ROI)
• Return on Invested Capital (ROIC)
• EBITDA Margin
• Net Profit Margin
• Operating Margin
• Current Ratio CURRENT ARTICLE
• Quick Ratio
• Operating Cash Flow Ratio
• Receivables Turnover Ratio
• Inventory Turnover
• Working Capital Turnover Definition
• Debt-To-Equity Ratio
• Total-Debt-to-Total-Assets Ratio
• Interest Coverage Ratio
• Shareholder Equity Ratio
• Price-to-Earnings Ratio
• Price-to-Book Ratio
• Price-to-Sales Ratio
• Price-to-Cash Flow Ratio

The current ratio is a liquidity ratio that measures a company’s ability to pay short-term obligations or those due within one year. It tells investors and analysts how a company can maximize the current assets on its balance sheet to satisfy its current debt and other payables.

A current ratio that is in line with the industry average or slightly higher is generally considered acceptable. A current ratio that is lower than the industry average may indicate a higher risk of distress or default by the company. If a company has a very high current ratio compared with its peer group, it indicates that management may not be using its assets efficiently.

The current ratio is called current because, unlike some other liquidity ratios, it incorporates all current assets and current liabilities . The current ratio is sometimes called the working capital ratio.

Key Takeaways

• The current ratio compares all of a company’s current assets to its current liabilities.
• The current ratio helps investors understand more about a company’s ability to cover its short-term debt, which can be used for comparisons with competitors and peers.
• Industries will have different expected or average current ratios, so it can't easily be used as a point of comparison between companies across different industries.
• Others limitations include the overgeneralization of the specific asset and liability balances, as well as the lack of trending information.

Investopedia / Lara Antal

Understanding the Current Ratio

The current ratio measures a company’s ability to pay current, or short-term, liabilities (debts and payables) with its current, or short-term, assets, such as cash, inventory, and receivables.

In many cases, a company with a current ratio of less than 1.00 does not have the capital on hand to meet its short-term obligations if they were all due at once, while a current ratio greater than 1.00 indicates that the company has the financial resources to remain solvent in the short term. However, because the current ratio at any one time is just a snapshot, it is usually not a complete representation of a company’s short-term liquidity or longer-term solvency .

For example, a company may have a very high current ratio, but its accounts receivable may be very aged , perhaps because its customers pay slowly, which may be hidden in the current ratio. Some of the accounts receivable may even need to be written off. Analysts also must consider the quality of a company’s other assets vs. its obligations. If the inventory is unable to be sold , the current ratio may still look acceptable at one point in time, even though the company may be headed for default.

Public companies don't report their current ratio, though all the information needed to calculate the ratio is contained in the company's financial statements.

A ratio under 1.00 indicates that the company’s debts due in a year or less are greater than its cash or other short-term assets expected to be converted to cash within a year or less. In general, the higher the current ratio, the more capable a company is of paying its obligations because it has a larger proportion of short-term asset value relative to the value of its short-term liabilities.

However, though a high ratio—say, more than 3.00—could indicate that the company can cover its current liabilities three times, it also may indicate that it is not using its current assets efficiently, securing financing very well, or properly managing its working capital . This is why it is helpful to compare a company's current ratio to those of similarly-sized businesses within the same industry.

Formula and Calculation for the Current Ratio

To calculate the ratio , analysts compare a company’s current assets to its current liabilities.

Current Ratio = Current assets Current liabilities \begin{aligned} &\text{Current Ratio}=\frac{\text{Current assets}}{ \text{Current liabilities}} \end{aligned} ​ Current Ratio = Current liabilities Current assets ​ ​

Current assets listed on a company’s balance sheet include cash , accounts receivable , inventory , and other current assets (OCA) that are expected to be liquidated or turned into cash in less than one year.

Current liabilities include accounts payable , wages, taxes payable, short-term debts, and the current portion of long-term debt.

A current ratio of less than 1.00 may seem alarming, but a single ratio doesn't always offer a complete picture of a company's finances.

For example, a normal cycle for the company’s collections and payment processes may lead to a high current ratio as payments are received, but a low current ratio as those collections ebb. Calculating the current ratio at just one point in time could indicate that the company can’t cover all of its current debts , but it doesn’t necessarily mean that it won’t be able to when the payments are due.

As another example, large retailers often negotiate much longer-than-average payment terms with their suppliers. If a retailer doesn’t offer credit to its customers, this can show on its balance sheet as a high payables balance relative to its receivables balance. Large retailers can also minimize their inventory volume through an efficient supply chain , which makes their current assets shrink against current liabilities, resulting in a lower current ratio.

The current ratio can be a useful measure of a company’s short-term solvency when it is placed in the context of what has been historically normal for the company and its peer group. It also offers more insight when calculated repeatedly over several periods.

Changes in the current ratio over time can often offer a clearer picture of a company's finances. A company that seems to have an acceptable current ratio could be trending toward a situation in which it will struggle to pay its bills. Conversely, a company that may appear to be struggling now could be making good progress toward a healthier current ratio.

In the first case, the trend of the current ratio over time would be expected to harm the company’s valuation. Meanwhile, an improving current ratio could indicate an opportunity to invest in an undervalued stock amid a turnaround.

Imagine two companies with a current ratio of 1.00 today. Though they may appear to have the same level of risk, analysts would have different expectations for each company depending on how the current ratio of each had changed over time.

In this example, the trend for Company B is negative, meaning the current ratio is decreasing over time. An analyst or investor seeing these numbers would need to investigate further to see what is causing the negative trend. It could be a sign that the company is taking on too much debt or that its cash balance is being depleted, either of which could be a solvency issue if the trend worsens.

On the other hand, the trend for Company A is positive. This could indicate that the company has better collections, faster inventory turnover , or simply a better ability to pay down its debt. The trend is also more stable, with all the values being relatively close together and no sudden jumps or increases from year to year. An investor or analyst looking at this trend over time would conclude that the company's finances are likely more stable, too.

This is markedly different from Company B's current ratio, which demonstrates a higher level of volatility. From 2020 to 2021, it jumps from 1.35 to 1.05 in a single year. This could indicate increased operational risk and a likely drag on the company’s value.

Example Using the Current Ratio

To see how current ratio can change over time, and why a temporarily lower current ratio might not bother investors or analysts, let's look at the balance sheet for Apple Inc.

In its Q4 2022 fiscal results, Apple Inc. reported total current assets of $135.4 billion, slightly higher than its total current assets at the end of the 2021 fiscal year of $134.8 billion. However, the company's liability composition significantly changed from 2021 to 2022. At the end of 2022, the company reported $154.0 billion of current liabilities, almost $29 billion greater than current liabilities from 2021.

For 2021, Apple had more current assets than current liabilities. Its current ratio was:

$134.836 billion / $125.481 billion = 1.075

If all current liabilities of Apple had been immediately due at the end of 2021, the company could have paid all of its bills without leveraging long-term assets.

At the end of 2022, however, Apple's current ratio was:

$135.405 billion / $153.982 billion = 0.88

Apple technically did not have enough current assets on hand to pay all of its short-term bills.

However, most analysts would not have been concerned, since Apple is a well-established company that could quickly move products through production, sell inventory, or secure short-term financing (with its $217 billion of non-current assets pledged as collateral, for instance).

And by the end of the 2023 fiscal year, the picture had changed yet again. Apple's current assets were $143.7 billion, while its current liabilities were nearly $134 billion, making its current ratio:

$143.692 billion / $133.973 billion = 1.07

This is once again in line with the current ratio from 2021, indicating that the lower ratio of 2022 was a short-term phenomenon.

Current Ratio vs. Other Liquidity Ratios

Other similar liquidity ratios can supplement a current ratio analysis. In each case, the differences in these measures can help an investor understand the current status of the company’s assets and liabilities from different angles, as well as how those accounts are changing over time.

The commonly used acid-test ratio , or quick ratio , compares a company’s easily liquidated assets (including cash, accounts receivable, and short-term investments, excluding inventory and prepaid expenses) to its current liabilities. The cash asset ratio , or cash ratio , also is similar to the current ratio, but it only compares a company’s marketable securities and cash to its current liabilities.

Companies may use days sales outstanding to better understand how long it takes for a company to collect payments after credit sales have been made. While the current ratio looks at the liquidity of the company overall, the days sales outstanding metric calculates liquidity specifically to how well a company collects outstanding accounts receivables.

Finally, the operating cash flow ratio compares a company’s active cash flow from operating activities (CFO) to its current liabilities. This allows a company to better gauge funding capabilities by omitting implications created by accounting entries.

Limitations of Using the Current Ratio

One limitation of the current ratio emerges when using it to compare different companies with one another. Businesses differ substantially among industries; comparing the current ratios of companies across different industries may not lead to productive insight.

For example, in one industry, it may be more typical to extend credit to clients for 90 days or longer, while in another industry, short-term collections are more critical. Ironically, the industry that extends more credit actually may have a superficially stronger current ratio because its current assets would be higher.

The current ratio is most useful when measured over time, compared against a competitor, or compared against a benchmark.

Another drawback of using the current ratio involves its lack of specificity. Unlike many other liquidity ratios, it incorporates all of a company’s current assets, even those that cannot be easily liquidated. For example, imagine two companies that both have a current ratio of 0.80 at the end of the last quarter . On the surface, this may look equivalent, but the quality and liquidity of those assets may be very different:

In this example, Company A has much more inventory than Company B, which will be harder to turn into cash in the short term. Perhaps this inventory is overstocked or unwanted, which eventually may reduce its value on the balance sheet. Company B has more cash, which is the most liquid asset, and more accounts receivable, which could be collected more quickly than liquidating inventory. Although the total value of current assets matches, Company B is in a more liquid, solvent position.

The current liabilities of Company A and Company B are also very different. Company A has more accounts payable, while Company B has a greater amount in short-term notes payable. This would be worth more investigation because it is likely that the accounts payable will have to be paid before the entire balance of the notes-payable account. Company A also has fewer wages payable, which is the liability most likely to be paid in the short term.

In this example, although both companies seem similar, Company B is likely in a more liquid and solvent position. An investor can dig deeper into the details of a current ratio comparison by evaluating other liquidity ratios that are more narrowly focused than the current ratio.

What Is a Good Current Ratio?

What counts as a good current ratio will depend on the company’s industry and historical performance. Current ratios over 1.00 indicate that a company's current assets are greater than its current liabilities, meaning it could more easily pay of short-term debts. A current ratio of 1.50 or greater would generally indicate ample liquidity.

What Happens If the Current Ratio Is Less Than 1?

As a general rule, a current ratio below 1.00 could indicate that a company might struggle to meet its short-term obligations, whereas ratios of above 1.00 might indicate a company is able to pay its current debts as they come due. If a company's current ratio is less than one, it may have more bills to pay than easily accessible resources to pay those bills.

What Does a Current Ratio of 1.5 Mean?

A current ratio of 1.5 would indicate that the company has $1.50 of current assets for every $1 of current liabilities. For example, suppose a company’s current assets consist of $50,000 in cash plus $100,000 in accounts receivable. Its current liabilities, meanwhile, consist of $100,000 in accounts payable. In this scenario, the company would have a current ratio of 1.5, calculated by dividing its current assets ($150,000) by its current liabilities ($100,000).

How Is the Current Ratio Calculated?

To calculate the current ratio, divide the company’s current assets by its current liabilities. Current assets are those that can be converted into cash within one year, while current liabilities are obligations expected to be paid within one year. Examples of current assets include cash, inventory, and accounts receivable. Examples of current liabilities include accounts payable, wages payable, and the current portion of any scheduled interest or principal payments. Both current assets and current liabilities are listed on a company's balance sheet.

The current ratio is a liquidity measurement used to track how well a company may be able to meet its short-term debt obligations. It compares the ratio of current assets to current liabilities. Measurements less than 1.0 indicate a company's potential inability to use current resources to fund short-term obligations.

The current ratio provides the most information when it is used to compare companies of similar sizes within the same industry. Since assets and liabilities change over time, it is also helpful to calculate a company's current ratio from year to year to analyze whether it shows a positive or negative trend.

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How to Calculate (And Interpret) The Current Ratio

Janet Berry-Johnson, CPA

Reviewed by

March 10, 2022

This article is Tax Professional approved

All businesses have bills to pay. Your ability to pay them is called "liquidity," and liquidity is one of the first things that accountants and investors will look at when assessing the health of your business.

I am the text that will be copied.

The current ratio (also known as the current asset ratio , the current liquidity ratio , or the working capital ratio ) is a financial analysis tool used to determine the short-term liquidity of a business. It takes all of your company’s current assets, compares them to your short-term liabilities, and tells you whether you have enough of the former to pay for the latter.

In other words, the current ratio is a good indicator of your company’s ability to cover all of your pressing debt obligations with the cash and short-term assets you have on hand. It’s one of the ways to measure the solvency and overall financial health of your company.

Here, we’ll go over how to calculate the current ratio and how it compares to some other financial ratios.

How do you calculate the current ratio?

You calculate your business’s overall current ratio by dividing your current assets by your current liabilities .

To do this, you’ll need to get familiar with your balance sheet —as one of the three primary financial statements your business produces, your balance sheet helps you get a sense of the big picture and serves as a historical record of a specific moment in time.

Current assets (also called short-term assets) are cash or any other asset that will be converted to cash within one year . You can find them on the balance sheet, alongside all of your business’s other assets.

The five major types of current assets are:

Cash and cash equivalents . These include cash and short-term securities that your business can quickly sell and convert into cash, like treasury bills, short-term government bonds, and money market funds.

Marketable securities . These typically have a maturity period of one year or less, are bought and sold on a public stock exchange, and can usually be sold within three months on the market. Examples include common stock, treasury bills, and commercial paper.

Accounts receivable . This account is used to keep track of any money customers owe for products or services already delivered and invoiced for.

Inventory . This includes all the goods and materials a business has stored for future use, like raw materials, unfinished parts, and unsold stock on shelves.

Prepaid expenses . These are future expenses that have been paid in advance that haven’t yet been used up or expired. Generally, prepaid expenses that will be used up within one year are initially reported on the balance sheet as a current asset. As the amount expires, the current asset is reduced and the amount of the reduction is reported as an expense on the income statement.

Your current liabilities (also called short-term obligations or short-term debt) are:

• Any outstanding bill payments
• Short-term loans
• Any other kind of short-term liability that your business must pay back within the next 12 months

You can find them on your company’s balance sheet, alongside all of your other liabilities.

Current liabilities do not include long-term debt, like bonds, lease obligations, and long-term notes payable.

Here are a few common examples of current liabilities:

• Credit card debt
• Notes payable that mature within one year
• Wages payable
• Deferred revenue
• Accounts payable
• Accrued liabilities (also known as accrued expenses) like dividend, income tax, and payroll

What is the current ratio formula?

You calculate the current ratio by dividing your company’s current assets by your current liabilities, i.e.:

Current ratio = total current assets / total current liabilities

Let’s imagine that your fictional company, XYZ Inc., has $15,000 in current assets and $22,000 in current liabilities. Its current ratio would be:

Current ratio = $15,000 / $22,000 = 0.68

That means that the current ratio for your business would be 0.68.

A company with a current ratio of less than one doesn’t have enough current assets to cover its current financial obligations. XYZ Inc.’s current ratio is 0.68, which may indicate liquidity problems.

But that’s also not always the case.

A low current ratio could also just mean that you’re in an industry where it’s normal for companies to collect payments from customers quickly but take a long time to pay their suppliers, like the retail and food industries.

Or it could mean that your company is very good at keeping inventory low. (Remember: inventory is included in current assets.)

A high current ratio, on the other hand, may indicate inefficient use of assets, or a company that’s hanging on to excess cash instead of reinvesting it in growing the business.

What is a good current ratio?

As with many other financial metrics, the ideal current ratio will vary depending on the industry, operating model, and business processes of the company in question.

In general, a current ratio between 1.5 and 3 is considered healthy. Ratios lower than 1 usually indicate liquidity issues, while ratios over 3 can signal poor management of working capital.

The definition of a “good” current ratio also depends on who’s asking. In many cases, lenders prefer high current ratios, since it indicates that the company won’t have any issues paying the creditor back, while investors may take a high current ratio as a signal of operational inefficiencies.

Current vs. quick ratio

The quick ratio (also sometimes called the acid-test ratio) is a more conservative version of the current ratio.

The quick ratio differs from the current ratio in that it leaves inventory out and keeps the three other major types of current assets: cash equivalents, marketable securities, and accounts receivable.

So the equation for the quick ratio is:

Quick ratio = (cash equivalents + marketable securities + accounts receivable) / current liabilities

Because inventory levels vary widely across industries, in theory, this ratio should give us a better reading of a company’s liquidity than the current ratio. But it’s important to put it in context.

A lower quick ratio could mean that you’re having liquidity problems, but it could just as easily mean that you’re good at collecting accounts receivable quickly.

Similarly, a higher quick ratio doesn’t automatically mean you’re liquid, especially if you encounter unexpected problems collecting receivables

Current vs. cash ratio

Looking for an even purer (in theory) liquidity test? You want the cash ratio.

The cash ratio takes accounts receivable out of the equation, leaving you with only cash equivalents and marketable securities to cover your current liabilities:

Cash ratio = (cash equivalents + marketable securities) / current liabilities

If you have a high cash ratio, you’re sitting pretty. It’s the most conservative measure of liquidity and, therefore, the most reliable, industry-neutral method of calculating it.

Advanced ratios

Financial analysts will often also use two other ratios to calculate the liquidity of a business: the current cash debt coverage ratio and the cash conversion cycle (CCC) .

The current cash debt coverage ratio is an advanced liquidity ratio. It measures how capable a business is of paying its current liabilities using the cash generated by its operating activities (i.e., money your business brings in from its ongoing, regular business activities).

The cash conversion cycle (CCC) is a metric that expresses the time (in days) it takes for a company to convert its investments in inventory and other resources into cash flows from sales.

These calculations are fairly advanced, and you probably won’t need to perform them for your business, but if you’re curious, you can read more about the current cash debt coverage ratio and the CCC .

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Current Ratio

Step-by-Step Guide to Understanding Current Ratio

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What is Current Ratio?

The Current Ratio is a measure of a company’s near-term liquidity position, or more specifically, the short-term obligations coming due within one year.

Often used alongside the quick ratio, the current ratio measures if a company can meet its short-term obligations using its short-term assets on the present date.

• The current ratio is a financial metric that measures the liquidity of a company by comparing the current assets belonging to a company to its current liabilities to determine if the liquid assets are sufficient to meet its short-term obligations coming due within twelve months (or one-year).
• The current ratio formula is the current assets of a company divided by its current liabilities.
• A current ratio of around 1.5x to 3.0x is considered to be healthy, whereas a current ratio below 1.0x is deemed a red flag that implies the near-term liquidity of the company presents risks.
• The current ratio is different from the quick ratio because the metric is less conservative because the formula includes all current assets, rather than only those confirmed to be truly liquid.

Table of Contents

How to Calculate Current Ratio

Current ratio formula, current ratio calculation example, what is a good current ratio, what are the limitations of current ratio, current ratio vs. quick ratio: what is the difference, current ratio calculator, 1. balance sheet assumptions, 2. working capital calculation example, 3. current ratio calculation example.

The current ratio is categorized as a liquidity ratio , since the financial metric assesses how financially sound the company is in relation to its near-term liabilities .

Liquidity ratios generally have a near-term focus, hence the two main inputs are current assets and current liabilities.

• Current Assets → Cash and Cash Equivalents, Marketable Securities, Accounts Receivable (A/R), Inventory
• Current Liabilities → Accounts Payable (A/P), Accrued Expense, Deferred Revenue (D/R), Short-Term Debt (<12 Month)

The current ratio reflects a company’s capacity to pay off all its short-term obligations, under the hypothetical scenario that short-term obligations are due right now.

The formula to calculate the current ratio divides a company’s current assets by its current liabilities.

Since the current ratio compares a company’s current assets to its current liabilities, the required inputs can be found on the balance sheet .

Often, the current ratio tends to also be a useful proxy for how efficient the company is at working capital management.

Suppose a company has the following balance sheet data:

Current Assets:

• Cash = $25 million
• Marketable Securities = $20 million
• Accounts Receivable (A/R) = $10 million
• Inventory = $60 million

Current Liabilities:

• Accounts Payable (A/P) = $55 million
• Short-Term Debt = $60 million

With that said, the required inputs can be calculated using the following formulas.

• Current Assets = $25 million + $20 million + $10 million + $60 million = $115 million
• Current Liabilities = $55 million + $60 million = $115 million

For the last step, we’ll divide the current assets by the current liabilities.

• Current Ratio = $115 million ÷ $115 million = 1.0x

The current ratio of 1.0x is right on the cusp of an acceptable value, since if the ratio dips below 1.0x, that means the company’s current assets cannot cover its current liabilities.

If the ratio were to drop below the 1.0x “floor”, raising external financing would become urgent.

The range used to gauge the financial health of a company using the current ratio metric varies on the specific industry.

For instance, supermarket retailers typically have low current ratios considering their business model (and free cash flows) are essentially a function of their ability to raise more debt to fund asset purchases (i.e. increases debt on B/S ), as well as pushing back supplier/vendor payments (i.e. increasing accounts payable )

As a general rule of thumb, a current ratio in the range of 1.5 to 3.0 is considered healthy.

• Current Ratio >1.5x → The company has sufficient current assets to pay off its current liabilities
• Current Ratio = 1.0x → The company has sufficient current assets to meet its current liabilities, however, there is no margin for error (i.e. no “cushion”)
• Current Ratio <1.0x → The company has insufficient current assets to pay off its current liabilities

However, a current ratio <1.0 could be a sign of underlying liquidity problems, which increases the risk to the company (and lenders if applicable).

Tracking the current ratio can be viewed as “worst-case” scenario planning (i.e. liquidation scenario) — albeit, the company’s business model may just require fewer current assets and comparatively more current liabilities.

Here, the company could withstand a liquidity shortfall if providers of debt financing see the core operations are intact and still capable of generating consistent cash flows at high margins.

But a higher current ratio is NOT necessarily always a positive sign — instead, a ratio in excess of 3.0x can result from a company accumulating current assets on its balance sheet (e.g. cannot sell inventory to customers).

While under a liquidation scenario, a higher amount of asset collateral is perceived positively, most companies focus on forward-looking performance like free cash flow (FCF) generation and profit margins , although everything is linked to one another in some ways.

The limitations of the current ratio – which must be understood to properly use the financial metric – are as follows.

• Minimum Cash Balance → One shortcoming of the metric is that the cash balance includes the minimum cash amount required for working capital needs. Without the minimum cash on hand for operations to continue, as usual, the business cannot continue to run if its cash were to dip below this level — e.g. the company is struggling to collect owed cash payments from customers that paid on credit.
• Restricted Cash → Likewise, the cash balance could contain restricted cash, which is not freely available for use by the business and is instead held for a specific purpose.
• Illiquid Short-Term Investments → Next, the inclusion of short-term investments that cannot be liquidated in the markets easily could also have been included — i.e. low liquidity and cannot sell without selling at a loss at a substantial discount.
• Bad A/R (Uncollectible) → The last drawback to the current ratio that we’ll discuss is the accounts receivable amount can include “Bad A/R”, which is uncollectible customer payments, but management refuses to recognize it as such.

Another practical measure of a company’s liquidity is the quick ratio , otherwise known as the “acid-test” ratio.

The formula to compute the quick ratio is as follows.

In comparison to the current ratio, the quick ratio is considered a more strict variation due to filtering out current assets that are not actually liquid — i.e. cannot be sold for cash immediately.

By adjusting the numerator to include solely highly liquid assets that can truly be converted into cash in <90 days with a high degree of certainty, the quick ratio is a more conservative measure of liquidity.

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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Suppose we’re tasked with analyzing the liquidity of a company with the following balance sheet data in Year 1.

• Cash and Cash Equivalents = $20 million
• Marketable Securities = $15 million
• Accounts Receivable (A/R) = $25 million
• Inventory = $65 million
• Accounts Payable: $45 million
• Short-Term Debt: $80 million

Putting the above together, the total current assets and total current liabilities each add up to $125m, so the current ratio is 1.0x as expected.

The company has just enough current assets to pay off its liabilities on its balance sheet.

As for the projection period – from Year 2 to Year 4 – we’ll use a step function for each B/S line item, with the Year 1 figures serving as the starting point.

Our assumptions for the changes in working capital line items are as follows.

• Cash and Cash Equivalents = +$5 million/Year
• Marketable Securities = +$5 million/Year
• Accounts Receivable (A/R) = +$3 million/Year
• Inventory = +$2 million/Year
• Accounts Payable (A/P) = –$3 million/Year
• Short-Term Debt = –$2 million/Year

Clearly, the company’s operations are becoming more efficient, as implied by the increasing cash balance and marketable securities (i.e. highly liquid, short-term investments), accounts receivable , and inventory.

By dividing the current assets balance of the company by the current liabilities balance in the coinciding period, we can determine the current ratio for each year.

From Year 1 to Year 4, the current ratio increases from 1.0x to 1.5x.

• Current Ratio – Year 1 = $125 million ÷ $125 million = 1.0x
• Current Ratio – Year 2 = $140 million ÷ $120 million = 1.2x
• Current Ratio – Year 3 = $155 million ÷ $115 million = 1.3x
• Current Ratio – Year 4 = $170 million ÷ $110 million = 1.5x

Note the growing A/R balance and inventory balance require further diligence, as the A/R growth could be from the inability to collect cash payments from credit sales .

The increase in inventory could stem from reduced customer demand, which directly causes the inventory on hand to increase — which can be good for raising debt financing (i.e. more collateral), but a potential red flag.

Therefore, applicable to all measures of liquidity, solvency , and default risk, further financial due diligence is necessary to understand the real financial health of our hypothetical company.

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What is the Current Ratio?

Current ratio formula, example of the current ratio formula, download the free current ratio formula template.

• Current Ratio Formula - What are Current Assets?
• Current Ratio Formula - What are Current Liabilities?

Why Use the Current Ratio Formula?

Additional resources.

Current Assets / Current Liabilities

The current ratio, also known as the working capital ratio, measures the capability of a business to meet its short-term obligations that are due within a year. The ratio considers the weight of total current assets versus total current liabilities .

It indicates the financial health of a company and how it can maximize the liquidity of its current assets to settle debt and payables. The current ratio formula (below) can be used to easily measure a company’s liquidity.

The Current Ratio formula is:

Current Ratio = Current Assets / Current Liabilities

If a business holds:

• Cash = $15 million
• Marketable securities = $20 million
• Inventory = $25 million
• Short-term debt = $15 million
• Accounts payables = $15 million

Current assets = 15 + 20 + 25 = 60 million

Current liabilities = 15 + 15 = 30 million

Current ratio = 60 million / 30 million = 2.0x

The business currently has a current ratio of 2, meaning it can easily settle each dollar on loan or accounts payable twice. A rate of more than 1 suggests financial well-being for the company. There is no upper end on what is “too much,” as it can be very dependent on the industry, however, a very high current ratio may indicate that a company is leaving excess cash unused rather than investing in growing its business.

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Current Ratio Formula – What are Current Assets?

Current assets are resources that can quickly be converted into cash within a year’s time or less. They include the following:

• Cash – Legal tender bills, coins, undeposited checks from customers, checking and savings accounts, petty cash
• Cash equivalents – Corporate or government securities with 90 days or less maturity
• Marketable securities – Common stock, preferred stock, government and corporate bonds with a maturity date of 1 year or less
• Accounts receivable – Money owed to the company by customers and that is due within a year – This net value should be after deducting an allowance for doubtful accounts (bad credit)
• Notes receivable – Debt that is maturing within a year
• Other receivables – Insurance claims, employee cash advances, income tax refunds
• Inventory – Raw materials, work-in-process, finished goods, manufacturing/packaging supplies
• Office supplies – Office resources such as paper, pens, and equipment expected to be consumed within a year
• Prepaid expenses – Unexpired insurance premiums, advance payments on future purchases

Current Ratio Formula – What are Current Liabilities?

Current liabilities are business obligations owed to suppliers and creditors, and other payments that are due within a year’s time. This includes:

• Notes payable – Interest and the principal portion of loans that will become due within one year
• Accounts payable or Trade payable – Credit resulting from the purchase of merchandise, raw materials, supplies, or usage of services and utilities
• Accrued expenses – Payroll taxes payable, income taxes payable, interest payable, and anything else that has been accrued for but an invoice is not received
• Deferred revenue – Revenue that the company has been paid for that will be earned in the future when the company satisfies revenue recognition requirements

This current ratio is classed with several other financial metrics known as liquidity ratios. These ratios all assess the operations of a company in terms of how financially solid the company is in relation to its outstanding debt. Knowing the current ratio is vital in decision-making for investors, creditors, and suppliers of a company. The current ratio is an important tool in assessing the viability of their business interest.

Other important liquidity ratios include:

• Acid-Test Ratio
• Quick Ratio

Below is a video explanation of how to calculate the current ratio and why it matters when performing an analysis of financial statements .

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Table of contents

What is the Current Ratio?

Calculating the current ratio, what are current assets, what are current liabilities, assessing current ratio changes, limitations of the current ratio, current ratio vs. other liquidity ratios, frequently asked questions.

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Current Ratio: Calculation and Uses

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In the dynamic world of finance, it’s essential to navigate the complexities of financial ratios. Today, we unravel the ‘Current Ratio,’ a key metric used to assess a company’s financial health.

The Current Ratio is a financial metric that shines a spotlight on a company’s short-term liquidity and ability to meet its immediate obligations. It’s a crucial tool for investors and analysts seeking insights into a company’s financial stability.

To calculate the Current Ratio, use the following formula:

Current Ratio = Current Assets / Current Liabilities

This formula provides a straightforward way to gauge a company’s liquidity and its ability to meet short-term financial obligations.

Current Ratio: An Example

If a company has $500,000 in current assets and $250,000 in current liabilities, its Current Ratio is 2 ($500,000 / $250,000), indicating that it has twice the assets to cover its immediate obligations.

Current assets, which constitute the numerator in the Current Ratio formula, encompass assets that are either in cash or will be converted into cash within a year. These typically include cash on hand, accounts receivable, and inventory. It represents the funds a company can access swiftly to settle short-term obligations.

The denominator in the Current Ratio formula, current liabilities, includes all the company’s short-term obligations, i.e., those due within one year. It encompasses items such as accounts payable, short-term loans, and any other debts requiring repayment in the near future.

The Current Ratio is not a static figure but can fluctuate. Various factors, such as changes in a company’s operations or economic conditions, can influence it. Monitoring a company’s Current Ratio over time helps in assessing its financial trajectory. For instance, if a company’s Current Ratio was 2 last year but is 1.5 this year, it may suggest that its liquidity has slightly decreased, which could be a cause for further investigation.

The Current Ratio, while valuable, has certain limitations:

Quality of Current Assets: It doesn’t distinguish between high-quality and low-quality current assets. For example, cash is a more liquid asset than slow-moving inventory. Therefore, a high Current Ratio may be misleading if it’s driven by less liquid assets.

Timing of Cash Flows: It doesn’t account for the timing of cash flows. A company might have a high level of accounts receivable, but if those receivables aren’t collected promptly, the company’s ability to meet short-term obligations may still be compromised.

Industry Variations: Industry norms vary, and a “good” Current Ratio in one sector may not be the same in another. It’s crucial to consider the industry in which a company operates when assessing its financial health.

Comparing the Current Ratio with other liquidity ratios, like the Quick Ratio or the Cash Ratio, can offer a more nuanced view of a company’s financial health. The Quick Ratio, for example, excludes inventory from current assets, providing a more conservative measure of liquidity. By examining multiple liquidity ratios, investors and analysts can gain a more complete understanding of a company’s short-term financial health.

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Q. What does a Current Ratio above 1 mean?

A Current Ratio greater than 1 indicates that a company has more assets than liabilities in the short term, which is generally considered a healthy financial position. It suggests that the company can comfortably cover its current obligations.

Q. Is a high Current Ratio always good?

While a high Current Ratio is generally positive, an excessively high ratio may indicate underutilized assets. It’s essential to consider industry norms and the company’s specific circumstances. For example, in some industries, like technology, companies may maintain lower Current Ratios as their assets are less liquid but still maintain financial health.

Q. What if the Current Ratio is less than 1?

If the Current Ratio is below 1, it implies that the company may struggle to meet its short-term obligations with its current assets. This could be a red flag for investors and creditors, indicating potential financial instability.

Q. How does the Current Ratio affect investment decisions?

Investors often use the Current Ratio to gauge a company’s financial stability and its ability to weather economic downturns. A strong Current Ratio can instill confidence in potential investors, but it should be evaluated alongside other financial metrics and the company’s specific circumstances.

Q. Can a company manipulate its Current Ratio?

In some cases, companies may attempt to improve their Current Ratio by delaying payments or accelerating the collection of accounts receivable. Analysts must be vigilant for such tactics, which can distort the true financial health of a company.

Q. The Significance of the Current Ratio

The Current Ratio provides valuable insights into a company’s liquidity. It’s particularly useful when assessing the short-term financial health of potential investment opportunities. This ratio, however, should not be viewed in isolation but rather as part of a holistic financial analysis.

Understanding the Current Ratio empowers investors and analysts to make informed decisions, enabling them to navigate the intricate world of finance with confidence. Whether you’re a seasoned pro or a newcomer to the world of investing, grasping the essentials of the Current Ratio is a critical step toward financial acumen.

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A Guide to the Current Ratio and How to Use It in Your Business

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Our Small Business Expert

Financial statements can tell you a lot about your business. They display the value of your assets, the amount of money you owe, the amount of revenue you’ve earned in a particular time frame, and even how much cash has gone into and out of your business.

But financial statements may not provide the answers to all the questions you have about your business. That’s where accounting ratios like the current ratio come in. The current ratio, like all accounting ratios, gives you answers to very specific questions. For example, if you want to know if your business has enough money to pay its bills, the current ratio can answer that question.

Overview: What is the current ratio?

For small business owners who don’t have an accounting background, accounting ratios may seem complex. While some of them are, most of the ratios that are useful for small businesses are easily calculated and require only a basic understanding of accounting.

That’s certainly the case with the current ratio. As a simple calculation, the current ratio answers one question: “Does my business have enough current assets to cover its current liabilities?”

In other words, if all the bills you have suddenly became due tomorrow, would you have enough current or liquid assets to cover them? Since the current ratio is only concerned with current assets and current liabilities, it’s one of the easiest ratios to calculate.

Your current or short-term assets may include the following:

• Cash and cash equivalents
• Accounts receivable
• Prepaid expenses
• Investments and securities

Current liabilities or current debt that should be included in the current ratio are:

• Accounts payable
• Notes payable (due in less than 12 months)
• Accrued expenses

If you’re using accounting software to help manage your business transactions, your balance sheet will automatically categorize current assets and current liabilities. If not, be sure to exclude fixed assets and long-term liabilities from your calculation.

How to calculate the current ratio

To calculate the current ratio for your business, you’ll need a current balance sheet. Once you have the balance sheet, you’ll need to locate your current asset balance and divide that by your current liability balance. The current ratio formula is:

Current ratio = Current Assets ÷ Current Liabilities

A balance sheet example displays assets, liabilities, and shareholders’ equity as of a particular date. Image source: Author

Using the balance sheet example for Teddy Fab Inc., let’s go ahead and calculate the current ratio.

$149,000 ÷ $47,000 = 3.17

This means that for every $1 that Teddy Fab has in liabilities, it has $3.17 worth of current assets. Businesses should ideally strive for a current ratio of at least 2, which indicates that the business has twice as much in assets as it does in liabilities.

What the current ratio tells you about a company

If you run the current ratio for your business, you’ll be able to see how financially stable your business is. Investors may also find the current ratio helpful when deciding to invest in a business.

Here are a few other things that the current ratio can tell you about the financial health of a business.

Whether the business can pay its bills

First and foremost, the current ratio tells you whether a company is in a position to pay its bills. Though many people look for a current ratio of at least 2, even 1.5 is considered adequate since it indicates that there are more current assets available to cover current liabilities.

If it will run out of money within the year

No one can predict this with guaranteed accuracy, but a current ratio of less than 1 can indicate that a company is in danger of running out of money within a year unless they’re able to increase cash flow or obtain funds from outside sources such as a loan from a financial institution or funds from an investor.

Whether revenue is being invested properly

While a low current ratio indicates possible financial difficulties, a high current ratio can signal that the company is not reinvesting in the business or paying dividends on earnings. And though a current ratio of 2 or higher is good, if it climbs too high, it may signal to investors a reluctance to invest in future company growth.

Limitations of the current ratio formula

The current ratio provides quick insight into a company’s finances, but it doesn’t present a complete picture. For example, a company with a current ratio of 4 due to high inventory value may not be as financially secure as a business with a current ratio of 3 that has a high value of cash and cash equivalents.

It doesn’t tell a complete story

The current ratio can tell you if you have enough assets to cover your liabilities. However, that information is only valuable if you know the story behind the numbers you’re using to calculate the current ratio.

For example, let’s compare the balance sheet accounts for two companies -- Hannah’s Hula Hoops and Bob’s Baseballs.

You’ll see that both Hannah’s Hula Hoops and Bob’s Baseballs have current assets and current liabilities in the same amount, resulting in the same current ratio.

$102,000 ÷ $50,000 = 2.04

However, both companies are not performing equally. If you examine the balance sheet numbers closely, you’ll see that much of Hannah’s current assets come from inventory, while Bob’s inventory is much lower. This is important to note because although inventory is a current asset, it’s also less liquid than other current assets.

You’ll also see that Bob’s cash and cash equivalents are much higher than Hannah’s. Bob’s also has a slightly higher accounts payable total than Hannah’s, but it’s not significant enough to make a difference.

When looking at the two companies, it’s evident that Bob’s Baseballs has more liquid assets than Hannah’s Hula Hoops, putting it in a more solvent position. But if all you knew about these two companies was their current ratio, you would assume they were in similar financial positions.

Comparison is limited

The current ratio can be helpful when analyzing your company’s financial liquidity, but how do you know how your company is performing against other companies?

The short answer is that you won’t unless you compare your company’s current ratio against a company in the same industry. If you own a sporting goods company, you should be comparing your current ratio results against other sporting goods companies, not the small manufacturing company that produces computer parts.

A final word about the current ratio

The current ratio is a good starting point for small business owners who want to stay on top of their business finances. While a current ratio can tell you a lot, there’s a lot that it doesn’t readily portray. So if you do calculate the current ratio for your business, be sure to take a closer look at the numbers behind that calculation.

When you feel comfortable with calculating ratios, consider calculating some other ratios that are particularly helpful for small businesses, including the quick ratio, net profit margin, and the asset turnover ratio.

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Current ratio

What is current ratio.

The current ratio is one of the most common measures of liquidity. It refers to the ratio of current assets to current liabilities.

Current Ratio Formula

The formula for current ratio is:

Current ratio = Current assets ÷ Current liabilities

Current assets include cash and cash equivalents, marketable securities, short-term receivables, inventories, and prepayments. Current liabilities include trade payables, current tax payable, accrued expenses, and other short-term obligations.

Current assets refer to cash and other resources that can be converted into cash in the short-term (within 1 year or the company's normal operating cycle, whichever is longer).

Current liabilities are obligations that are to be settled within 1 year or the normal operating cycle.

XYZ Company had the following figures extracted from its books of accounts.

Interpreting the Current Ratio

If the current ratio computation results in an amount greater than 1, it means that the company has adequate current assets to settle its current liabilities. In the above example, XYZ Company has current assets 2.32 times larger than current liabilities. In other words, for every $1 of current liability, the company has $2.32 of current assets available to pay for it.

A high current ratio is generally considered a favorable sign for the company. Creditors are more willing to extend credit to those who can show that they have the resources to pay obligations. However, a current ratio that is too high might indicate that the company is missing out on more rewarding opportunities. Instead of keeping current assets (which are idle assets), the company could have invested in more productive assets such as long-term investments and plant assets.

The ideal current ratio is proportional to the operating cycle. Companies with shorter operating cycles, such as retail stores, can survive with a lower current ratio than, say for example, a ship-building company. The current ratio should be compared with standards -- which are often based on past performance, industry leaders, and industry average.

The current ratio is a very common financial ratio to measure liquidity.

Current ratio is equal to total current assets divided by total current liabilities.

A ratio greater than 1 means that the company has sufficient current assets to pay off short-term liabilities.

A high ratio implies that the company has a thick liquidity cushion.

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A Refresher on Current Ratio

by Amy Gallo

One of the biggest fears of a small business owner is running out of cash. But large businesses in financial trouble face the same risk. To know whether a company is truly on the cusp of hitting a $0 balance in their accounts, you can’t simply look at the income statement. You need to run a simple calculation using a few figures.

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Current ratio: What it is and how to calculate it

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The current ratio shows a company’s ability to meet its short-term obligations. The ratio is calculated by dividing current assets by current liabilities. An asset is considered current if it can be converted into cash within a year or less, while current liabilities are obligations expected to be paid within one year.

Investors can use this type of liquidity ratio to make comparisons with a company’s peers and competitors. Ultimately, the current ratio helps investors understand a company’s ability to cover its short-term debts with its current assets.

Why the current ratio matters

You’ll want to consider the current ratio if you’re investing in a company. When a company’s current ratio is relatively low, it’s a sign that the company may not be able to pay off its short-term debt when it comes due, which could hurt its credit ratings or even lead to bankruptcy. 

For example, a company’s current ratio may appear to be good, when in fact it has fallen over time, indicating a deteriorating financial condition. But a too-high current ratio may indicate that a company is not investing effectively, leaving too much unused cash on its balance sheet.

The current ratio should be placed in the context of the company’s historical performance and that of its peers. A current ratio can be better understood by looking at how it changes over time. 

The current ratio is part of what you need to understand when investing in individual stocks , but those investing in mutual funds or exchange-trade funds needn’t worry about it.

How to calculate the current ratio

You can calculate the current ratio by dividing a company’s total current assets by its total current liabilities. Again, current assets are resources that can quickly be converted into cash within a year or less, including cash, accounts receivable and inventories.

Current liabilities include accounts payable, wages, accrued expenses, accrued interest and short-term debt.

The formula is:

Current ratio: Current assets / Current liabilities

Sample current ratios

Let’s look at some examples of companies with high and low current ratios. You can find these numbers on a company’s balance sheet under total current assets and total current liabilities. Some finance sites also give you the ratio in a list with other common financials, such as valuation, profitability and capitalization. You’ll find the current ratio with other liquidity ratios.

• General Electric’s (GE) current assets in December 2021 were $65.5 billion; its current liabilities were $51.95 billion, making its current ratio 1.26.
• Target (TGT)’s 2022 current ratio was 0.99: its current assets were $21.57 billion and its current liabilities were $21.75 billion.
• Intel (INTC) at year-end 2023 had $43.27 billion in current assets and $28.05 billion in current liabilities, for a high 1.54 current ratio.

What is a good current ratio?

The ideal current ratio varies by industry. However, an acceptable range for the current ratio could be 1.0 to 2. Ratios in this range indicate that the company has enough current assets to cover its debts, with some wiggle room. A current ratio lower than the industry average could mean the company is at risk for default, and in general, is a riskier investment.

However, special circumstances can affect the meaningfulness of the current ratio. For example, a financially healthy company could have an expensive one-time project that requires outlays of cash, say for emergency building improvements. Because buildings aren’t considered current assets, and the project ate through cash reserves, the current ratio could fall below 1.00 until more cash is earned.

Similarly, companies that generate cash quickly, such as well-run retailers, may operate safely with lower current ratios. They may borrow from suppliers (increasing accounts payable) and actually receive payment from their customers before the money is due to those suppliers. For example, Walmart had a 0.83 current ratio as of January 2024. In this case, a low current ratio reflects Walmart’s strong competitive position.

The best long-term investments manage their cash effectively, meaning they keep the right amount of cash on hand for the needs of the business.

What is a bad current ratio?

A current ratio below 1.0 suggests that a company’s liabilities due in a year or less are greater than its assets. A low current ratio could indicate that the company may struggle to meet its short-term obligations.

However, similar to the example we used above, special circumstances can negatively affect the current ratio in a healthy company. For instance, imagine Company XYZ, which has a large receivable that is unlikely to be collected or excess inventory that may be obsolete. Both circumstances could reduce the current ratio at least temporarily.

Current ratio vs. quick ratio vs. debt-to-equity

Other measures of liquidity and solvency that are similar to the current ratio might be more useful, depending on the situation. For instance, while the current ratio takes into account all of a company’s current assets and liabilities, it doesn’t account for customer and supplier credit terms, or operating cash flows.

A more conservative measure of liquidity is the quick ratio — also known as the acid-test ratio — which compares cash and cash equivalents only, to current liabilities. In contrast, the current ratio includes all of a company’s current assets, including those that may not be as easily converted into cash, such as inventory, which can be a misleading representation of liquidity.

To measure solvency, which is the ability of a business to repay long-term debt and obligations, consider the debt-to-equity ratio. This ratio compares a company’s total liabilities to its total equity. It measures how much creditors have provided in financing a company compared to shareholders and is used by investors as a measure of stability. A highly leveraged company is generally a riskier investment.

Bottom line

The current ratio is just one indicator of financial health. Like most performance measures, it should be taken along with other factors for well-contextualized decision-making.

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Home > Financial Projections > Current Ratio Formula

Current Ratio Formula

Liquidity is the ability of a business to utilize its short term assets (cash, accounts receivable and inventories) to meet its short term liabilities as they fall due. To this end the financial projections template uses the current ratio as an indicator of the liquidity of the business.

If the value is greater than one it shows that current assets are larger than current liabilities and indicates that the business should be able to convert its short term assets (cash, inventory, accounts receivable) into cash and pay its short term liabilities (accounts payable).

Ideally the value should be greater than one and, to provide a margin of safety, should be in the region of two.

Current Ratio Example

As an illustration we use the balance sheet below to show how to calculate the ratio.

To demonstrate the numbers used in the calculation are highlighted in the balance sheet shown. As can be seen in the above example the current assets are 680 and the current liabilities are 425.

In this case a value of 1.6 indicates that the current assets are 1.6 times greater than the current liabilities, and that the business should be able to pay its short term liabilities as they fall due.

The current ratio is reported on the ratios page of the financial projections template and should be monitored to ensure that it shows a value which is improving over time and is at least equal to one.

This current ratio will vary from industry to industry, and therefore it is important when making comparisons to determine an industry current ratio based on financial statements of businesses similar to your own.

While an increasing value can indicate increasing liquidity, a value which is too high implies a lot of funds are tied up in accounts receivables, inventories or as cash. It is generally accepted that funds tied up in this way earn very little or nothing for the business.

The current ratio is one of many financial ratio formulas used to analyse accounting financial statements.

About the Author

Chartered accountant Michael Brown is the founder and CEO of Plan Projections. He has worked as an accountant and consultant for more than 25 years and has built financial models for all types of industries. He has been the CFO or controller of both small and medium sized companies and has run small businesses of his own. He has been a manager and an auditor with Deloitte, a big 4 accountancy firm, and holds a degree from Loughborough University.

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Current Ratio Calculation

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on April 16, 2023

Are You Retirement Ready?

Table of contents, current ratio definition.

The current ratio is a liquidity ratio that is used to calculate a company's ability to meet its short-term debt and obligations, or those due in a single year, using assets available on its balance sheet .

It is also known as working capital ratio. A current ratio of one or more is preferred by investors.

A current ratio less than one is an indicator that the company may not be able to service its short-term debt.

On the other hand, a current ratio greater than one can also be a sign that the company has too much unsold inventory or cash on hand.

Current Ratio Formula

Current assets refers to the sum of all assets that will be used or turned to cash in the next year.

This list includes cash, inventory, and accounts receivables . Current liabilities refers to the sum of all liabilities that are due in the next year.

This list includes wages, accounts payable and mortgage payments and loans.

For example, if a company has $100,000 in current assets and $150,000 in current liabilities , then its current ratio is 0.6.

What Does the Current Ratio Measure?

Current ratios can vary depending on industry, size of company, and economic conditions.

Industries with predictable, recurring revenue , such as consumer goods, often have lower current ratios while cyclical industries, such as construction, have high current ratios. Even within an industry, current ratios can differ between companies.

For example, supplier agreements can make a difference to the number of liabilities and assets. A large retailer like Walmart may negotiate favorable terms with suppliers that allow it to keep inventory for longer periods and have generous payment terms or liabilities.

What Is a Good Current Ratio?

During times of economic growth , investors prefer lean companies with low current ratios and ask for dividends from companies with high current ratios.

But, during recessions , they flock to companies with high current ratios because they have current assets that can help weather downturns.

Current ratios are not always a good snapshot of company liquidity because they assume that all inventory and assets can be immediately converted to cash. This may not always be the case, especially during economic recessions.

In such cases, acid-test ratios are used because they subtract inventory from asset calculations to calculate immediate liquidity.

Current Ratio Calculation FAQs

What is the current ratio.

The current ratio is a liquidity ratio that is used to calculate a company’s ability to meet its short-term debt and obligations, or those due in a single year, using assets available on its balance sheet.

What is the formula for the Current Ratio?

The formula for the current ratio is: Current Ratio = Current Assets / Current Liabilities

What is a good current ratio?

A current ratio of one or more is preferred by investors.

What's an example of current ratio?

For example, if a company has $100,000 in current assets and $150,000 in current liabilities, then its current ratio is 0.6.

How reliable is the current ratio?

Current ratios are not always a good snapshot of company liquidity because they assume that all inventory and assets can be immediately converted to cash. This may not always be the case, especially during economic recessions. In such cases, acid-test ratios are used because they subtract inventory from asset calculations to calculate immediate liquidity.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon , Nasdaq and Forbes .

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Current Ratio

What Is Current Ratio?

The current ratio is a commonly-used financial ratio . It tells investors and analysts whether a company is able to pay its current liabilities with its current assets (typically within a 12-month period).

Current Ratio Formula

To calculate current ratio, you’ll need the firm’s balance sheet and the following formula:

Current Ratio Example

Let's look at the balance sheet for Company XYZ:

We can calculate Company XYZ's current ratio as: 2,000 / 1,000 = 2.0

At the end of 2020, Company XYZ had $2.00 in current assets for every dollar of current liabilities. This means that Company XYZ should easily be able to cover its short-term debt obligations.

What Does a Higher Current Ratio Mean?

A company with a current ratio of between 1.2 and 2 is typically considered good. The higher the current ratio, the more liquid a company is. However, if the current ratio is too high (i.e. above 2), it might be that the company is unable to use its current assets efficiently.

A higher current ratio indicates that a company is able to meet its short-term obligations. In the example above, if all of Company XYZ's current liabilities were due on January 1, 2021, the firm would be able to meet those obligations with cash.

What Does a Current Ratio Increase Mean?

An increase in current ratio can mean a company is 'growing into' its capacity.

It’s important to remember, however, that major purchases that prepare for upcoming growth – or the sale of unnecessary assets – can suddenly and somewhat artificially change a company's current ratio.

What Does a Decreasing Current Ratio Indicate?

Generally, a decrease in current ratio means that there are problems with inventory management , ineffective or lax standards for collecting receivables, or an excessive cash burn rate.

If a company’s current ratio falls below 1, the company likely won’t have enough liquid assets to pay off its liabilities. While a decreasing current ratio indicates poor financial health, it doesn’t necessarily mean that the company will fail.

Why Is Current Ratio Important?

Tracking the current ratio and other liquidity ratios helps an investor assess the health of a company. More specifically, investors will understand how the company is able to cover its short-term debts (compared to its industry competitors).

Comparing Current Ratios Between Industries

Comparison of current ratios is generally most meaningful among companies within the same industry. Therefore, the definition of a 'high' or 'low' ratio should be made within this context.

For example, if Company XYZ is a retail company, it would only make sense to compare its current ratio with other retail companies (not a construction company).

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How To Increase Current Ratio: Improve Liquidity For Business

Dec 23, 2021.

How liquid is your business? The answer lies in a metric called the current ratio, also known as the working capital ratio, which indicates your ability to repay short-term debts in the next 12 months. Keeping an eye on this number can help you gauge the company’s financial health as you increase liquidity. By taking steps to improve the current ratio, you increase liquidity and raise the business’ standing in the eyes of lenders, investors, and other stakeholders. 

How can a company improve its current ratio? This comprehensive guide to business liquidity gives you strategies that will move the needle in a positive direction.

Defining and calculating the current ratio

Before you learn how to improve current ratio, you have to know how to calculate this number. The formula for a current ratio is simple: Divide the company’s current assets by its current liabilities. In the assets category, be sure to account for:

• Cash and equivalents of cash on hand
• Operating expenses paid in advance
• Current inventory of products, raw materials, and in-progress productions
• Accounts receivables due within the next year
• Investments
• Office supplies
• Debt payments made in advance

Liabilities include all your company’s outstanding debt obligations as well as short-term notes, accrued income taxes and expenses, accrued compensation, and deferred revenues. It also covers the portion of long-term debt due in the next year. 

Let’s look at an example calculation to help you understand how to increase liquidity. If your company has $10 million in assets and $8 million in debts, its current ratio is 10/8 or 1.25. In other words, for every $1 in debt, your company has $1.25 in corresponding assets.

A ratio greater than 1 represents the favorable financial position of having more assets than debts. Conversely, a current ratio lower than 1 means the business’ debts exceed its assets, which can be a red flag for financial danger and signifies that you need to improve liquidity. A ratio higher than 3 could show an inefficient use of working capital.

Current ratio vs. quick ratio

You might also hear about another key metric, the quick ratio. Like the current ratio, the quick ratio measures your company’s short-term liquidity, but it accounts for fewer assets, which creates a more conservative estimate. To find your quick ratio, start with the current ratio equation. For assets, count only accounts receivable, sellable stocks and securities, cash, and cash equivalents. Use the same debts as with the current ratio calculation. If you’re wondering how to improve quick ratio, boosting your current ratio will put you on the right path. 

Improving your company’s current ratio

The ideal current ratio varies by industry, but you should aim to be at or above the average in your sector. Fortunately, smart strategies can change the direction of this number for the better. 

Reconfigure debt

Repaying or restructuring debt will raise the current ratio. Explore whether you can reamortize existing term loans and change how the lender charges you interest, effectively delaying debt payments so they drop off your current ratio. Negotiate longer payment cycles whenever possible. For example, you may be able to shift short-term debt into a long-term loan to reduce its impact on liquidity. 

Enhance asset management

With a sweep account , the company’s cash on hand can earn interest while remaining available for operating expenses. These accounts “sweep” excess cash into an interest-bearing account and return them to your operating account when it’s time to pay bills. 

Consider selling unused capital assets that don’t create a return. This cash infusion increases your short-term assets column, which, in turn, increases the company’s current ratio. Buildings, equipment, vehicles, outdated inventory, and other items that do not bring funds into the business represent liabilities you can convert to cash. 

If outstanding accounts payable have reduced the company’s liquidity, consider amplifying efforts to collect on these debts. Issue invoices as quickly as possible after a purchase. Establish clear payment terms at the outset, including late fees and interest on past-due balances. Conduct a close review of the business’ accounts payable process and look for inefficiencies that delay payments and prevent prompt collections.

Reduce expenses

If possible, cut down on spending to increase current ratio. Review the budget carefully and see where you can reduce line items like marketing, advertising, labor, and services. These indirect costs add up over time and take a big chunk out of your operating assets, but they often go unnoticed. 

At the same time, consider limiting personal draws on the business. By taking these profits out of circulation, you reduce the amount of available operating capital, decreasing your current ratio. The more cash you dedicate to operating the company, the better current ratio you’ll achieve. 

Whenever possible, finance or delay capital purchases that require a significant outlay of cash. Spending your operating funds on major expenses will quickly draw this ratio below 1. 

Keep in mind that the company’s current ratio naturally changes over time as you repay debt and acquire new assets and debts. Now that you know how to improve liquidity, monitoring this number periodically helps you stay on track and illustrates the impact of implementing these strategies.

About the Author:

Jack Sadden is a Partner and co-founder of Valesco Industries and is primarily focused on various initiatives around strategic leadership of the firm, portfolio company performance, and investment origination. He is a graduate of the Florida State University School of Business and is a licensed Certified Public Accountant.

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How can a company improve its current ratio.

• Last Updated: August 25, 2024

Guillermo Valles

In the complex world of business finance, the current ratio stands out as a crucial indicator of a company's short-term financial health. It's a simple yet powerful tool that gives stakeholders a snapshot of how well a company can meet its short-term obligations with its short-term assets. This metric not only influences day-to-day operations but also shapes investor confidence and creditworthiness.

But what happens when a company's current ratio isn't up to par? How can it navigate through the choppy waters of financial management to improve this vital statistic? This article delves deep into practical, effective strategies to enhance a company's current ratio. Whether you're a seasoned financial expert or a budding entrepreneur, understanding how to optimize this ratio is essential for steering your company towards sustained financial health and growth.

What is the Current Ratio?

Definition and calculation, interpreting the current ratio.

• Example Calculation: Apple's Current Ratio in 2022

Why It Matters

The current ratio , a cornerstone of financial analysis, is a key indicator of a company's liquidity. Simply put, it measures a company's ability to pay off its short-term liabilities with its short-term assets. This ratio is a critical component of financial health, providing insights into a company's operational efficiency and financial stability.

The current ratio is calculated by dividing a company's current assets by its current liabilities. The formula is:

Current Ratio = Current Assets / Current Liabilities

Current assets include: cash, cash equivalents, marketable securities, inventory, and accounts receivable — essentially, assets that can be converted into cash within a year.

Current liabilities, on the other hand, comprise obligations the company expects to settle within the same period, such as accounts payable, short-term debt, and other similar liabilities.

A higher current ratio indicates a greater level of liquidity, suggesting that a company is more capable of paying off its short-term obligations without raising additional capital. Typically, a ratio of 1 or above is considered healthy, implying that current assets equal or exceed current liabilities. However, this benchmark can vary across industries.

A ratio significantly above 1 might indicate that a company is not effectively using its short assets or may have too much inventory. Conversely, a ratio below 1 suggests that a company might struggle to meet its short-term obligations, potentially leading to liquidity problems.

Example Calculation: Apple's Current Ratio in 2022

To illustrate the practical application of the current ratio, let's examine a real-world example: Apple Inc. in 2022. This example will help demystify the concept and show how it can be applied to assess the financial health of a major corporation.

Gathering Financial Data

The first step in calculating the current ratio is to obtain the necessary financial data. This information can be found in a company's balance sheet, which is publicly available in its annual report or through financial news and data services. For Apple, we'll look at the figures reported in their 2022 financial statements.

According to Apple's balance sheet for the fiscal year ending in 2022:

• Current Assets: These include cash and cash equivalents, short-term marketable securities, accounts receivable, inventories, and other current assets. Let’s assume the total current assets were valued at $143.566 billion.
• Current Liabilities: These encompass accounts payable, accrued expenses, and other current liabilities. Let’s say the total current liabilities were $145.303 billion.

Calculating the Ratio

Now, we apply the current ratio formula:

Plugging in Apple’s figures:

Current Ratio= $143.566 billion / $145.303 billion

Current Ratio = 0.98

Interpreting the Result

With a current ratio of approximately 0.99, Apple demonstrates a nearly balanced liquidity position in this example. This ratio indicates that for every dollar of its short-term liabilities, Apple has almost an equal amount in short-term assets. While this ratio is slightly below the ideal benchmark of 1, it still suggests that the company is almost able to cover its short-term obligations with its current assets. This close to 1:1 ratio points towards a reasonable level of financial stability, although it also suggests there could be room for improvement in managing its working capital more efficiently. Such a ratio, especially for a large and established company like Apple, often reflects a nuanced balance between maintaining sufficient liquidity and efficient use of assets.

Automatic Current Ratio Calculation

Instead of manually calculating the current ratio as well as hundreds of other financial numbers and metrics , you can get them all automatically on your spreadsheet using Wisesheets .

You can easily build custom stock screeners like this:

Or build custom-made stock analysis models and get the metric granularly. For example, to get the current ratio for Microsoft in 2022, all you need to do is enter =WISE("msft", "current ratio", 2022).

This allows you to build complex models that provide you with all the data you need for your stock analysis very quickly.

Get your free trial here.

Understanding the current ratio is vital for several reasons:

• Risk Assessment : It helps investors and creditors assess the risk of investing or lending to a company.
• Operational Insight : It provides a snapshot of how well a company manages its working capital.
• Comparative Analysis : It allows for comparison with industry benchmarks and competitors, offering a perspective on a company's relative financial health.

The current ratio is not just a number but a reflection of a company’s financial agility. As we proceed, we will explore the nuances of this ratio and the strategies to optimize it, ensuring that your company not only survives but thrives in the competitive business environment.

Improving a company's current ratio is crucial for enhancing its financial stability and attractiveness to investors and creditors. A healthy current ratio indicates a company's proficiency in managing its working capital and its ability to meet short-term obligations. Here, we explore various strategies that companies can adopt to improve this key financial metric.

1. Increasing Current Assets

• Enhance Receivables Collection : Implementing more efficient accounts receivable management can speed up cash inflow. This includes tightening credit terms, offering discounts for early payments, and using automated reminder systems for overdue accounts.
• Optimize Inventory Levels : Reducing excess inventory can free up cash and increase current assets. Techniques like Just-in-Time (JIT) inventory management can be highly effective.
• Diversify Revenue Streams : Exploring new revenue channels can boost current assets. This could involve launching new products or services or expanding into new markets.

2. Reducing Current Liabilities

• Extend Payment Terms with Suppliers : Negotiating longer payment terms with suppliers can defer outflows, reducing current liabilities.
• Restructure Short-term Debt : Refinancing short-term debt into long-term liabilities can improve the current ratio, although this should be approached with caution to avoid long-term financial strain.
• Control Expenditures : Reducing unnecessary expenses and controlling operational costs can also help in lowering current liabilities.

3. Balanced Approach to Assets and Liabilities

• Regular Monitoring : Consistently tracking the current ratio allows for timely adjustments in strategy.
• Sustainable Financial Practices : Encouraging a culture of financial discipline within the organization can ensure that both assets and liabilities are managed wisely.

4. Leveraging Financial Tools and Technology

• Use of Financial Software : Implementing financial management software can provide real-time insights into the company's financial status, helping in making informed decisions.
• Data-Driven Decision Making : Utilizing data analytics can aid in predicting cash flow trends and making strategic decisions to maintain a healthy current ratio.

We've seen how increasing current assets, reducing current liabilities, and maintaining a balanced approach to managing assets and liabilities can significantly improve a company's current ratio. The strategies outlined here, from optimizing receivables and inventory management to restructuring debts and leveraging financial tools, are not just theoretical concepts but practical steps that can lead to tangible improvements in a company's financial health.

It's important to remember that the goal of improving the current ratio is not just to hit a target number but to foster a sustainable, financially sound business environment. A healthy current ratio is a sign of a company's resilience, efficiency, and attractiveness to investors and creditors. It speaks volumes about a company’s capability to navigate the ebbs and flows of business cycles and emerge as a robust, dependable, and thriving entity.

Hello! I'm a finance enthusiast who fell in love with the world of finance at 15, devouring Warren Buffet's books and streaming Berkshire Hathaway meetings like a true fan.

I started my career in the industry at one of Canada's largest REITs, where I honed my skills analyzing and facilitating over a billion dollars in commercial real estate deals.

My passion led me to the stock market, but I quickly found myself spending more time gathering data than analyzing companies.

That's when my team and I created Wisesheets, a tool designed to automate the stock data gathering process, with the ultimate goal of helping anyone quickly find good investment opportunities.

Today, I juggle improving Wisesheets and tending to my stock portfolio, which I like to think of as a garden of assets and dividends. My journey from a finance-loving teenager to a tech entrepreneur has been a thrilling ride, full of surprises and lessons.

I'm excited for what's next and look forward to sharing my passion for finance and investing with others!

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How to Use These Common Business Ratios

2 min. read

Updated October 27, 2023

What business ratios should you know and be using? Here’s a breakdown of common ratios, how they’re used, and in some cases how you’ll calculate them.

Main ratios

• Current. Measures company’s ability to meet financial obligations. Expressed as the number of times current assets exceed current liabilities. A high ratio indicates that a company can pay its creditors. A number less than one indicates potential cash flow problems.
• Quick. This ratio is very similar to the Acid Test (see below), and measures a company’s ability to meet its current obligations using its most liquid assets. It shows Total Current Assets excluding Inventory divided by Total Current Liabilities.
• Total Debt to Total Assets. Percentage of Total Assets financed with debt.
• Pre-Tax Return on Net Worth. Indicates shareholders’ earnings before taxes for each dollar invested. This ratio is not applicable if the subject company’s net worth for the period being analyzed has a negative value.
• Pre-Tax Return on Assets. Indicates profit as a percentage of Total Assets before taxes. Measures a company’s ability to manage and allocate resources.

Additional ratios

• Net Profit Margin. This ratio is calculated by dividing Sales into the Net Profit, expressed as a percentage.
• Return on Equity. This ratio is calculated by dividing Net Profit by Net Worth, expressed as a percentage.

Activity ratios

• Accounts Receivable Turnover. This ratio is calculated by dividing Sales on Credit by Accounts Receivable. This is a measure of how well your business collects its debts.
• Collection Days. This ratio is calculated by multiplying Accounts Receivable by 360, which is then divided by annual Sales on Credit. Generally, 30 days is exceptionally good, 60 days is bothersome, and 90 days or more is a real problem.
• Inventory Turnover. This ratio is calculated by dividing the Cost of Sales by the average Inventory balance.
• Accounts Payable Turnover. This ratio is a measure of how quickly the business pays its bills. It divides the total new Accounts Payable for the year by the average Accounts Payable balance.
• Payment Days. This ratio is calculated by multiplying average Accounts Payable by 360, which is then divided by new Accounts Payable.
• Total Asset Turnover. This ratio is calculated by dividing Sales by Total Assets.

Debt ratios

• Debt to Net Worth. This ratio is calculated by dividing Total Liabilities by total Net Worth.
• Current Liab. to Liab. This ratio is calculated by dividing Current Liabilities by Total Liabilities.

Liquidity ratios

• Net Working Capital. This ratio is calculated by subtracting Current Liabilities from Current Assets. This is another measure of cash position.
• Interest Coverage. This ratio is calculated by dividing Profits Before Interest and Taxes by total Interest Expense.
• Assets to Sales. This ratio is calculated by dividing Assets by Sales.
• Current Debt/Total Assets. This ratio is calculated by dividing Current Liabilities by Total Assets.
• Acid Test. This ratio is calculated by dividing Current Assets (excluding Inventory and Accounts Receivable) by Current Liabilities.
• Sales/Net Worth. This ratio is calculated by dividing Total Sales by Net Worth.
• Dividend Payout. This ratio is calculated by dividing Dividends by Net Profit.

In the real world, financial profile information involves some compromise. Very few organizations fit any one profile exactly. Variations, such as doing several types of business under one roof, are quite common. If you cannot find a classification that fits your business exactly, use the closest one and explain in your text how and why your business is different from the standard.

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Is Your Business Healthy? Use Financial Ratios to Find Out

Give your business a quick checkup

Susan Ward wrote about small businesses for The Balance for 18 years. She has run an IT consulting firm and designed and presented courses on how to promote small businesses.

Current Ratio

Total debt ratio, profit margin, applying the ratios, debt-to-equity ratio.

Analyzing business financial ratios allows lenders to see how your business is doing and compare it to other businesses. Ratio analysis also is a useful tool for business owners. Some basic ratio analysis helps you to assess how healthy your business is, diagnose potential problems, and see if your business is doing better or worse over time. The first step is understanding how to calculate different ratios and interpret the results.

The current ratio measures whether or not your business has enough resources to pay its bills over the next 12 months.

Current ratio = Current assets/Current liabilities

Current assets are a category of assets on the balance sheet that represents cash and assets that are expected to be converted into cash within one year. Current liabilities are a category of liabilities on the balance sheet that represent financial obligations that are expected to be settled within one year.

Suppose a business has $8,472 in current assets and $7,200 in current liabilities. Then the current ratio is $8,472/$7200 = 1.18:1.

So for this business, the current ratio gives a clean bill of health. For every dollar in current liabilities, there is $1.18 in current assets, and a current ratio greater than 1.0 generally is good. If you are comparing your current ratio from year to year and it seems abnormally high, you may be carrying too much inventory.

Total debt ratio does exactly what the name suggests: It shows how much your business is in debt. Understanding this ratio is an excellent way to check your business’s long-term solvency.

Total debt ratio = Total debt/Total assets

You can take these numbers from your balance sheet and plug them in. For instance, a business with $22,375 in total assets and $25,000 in total debt would have a total debt ratio of:

$25,000/$22,375 = 1.11:1

This business, then, is $1.11 in debt for every dollar of assets. So for this business, the total debt ratio tells us that this business is not in good health and may become ill. For good health, the total debt ratio should be 1.0 or less.

The lower the debt ratio, the less total debt the business has in comparison to its asset base. On the other hand, businesses with high total debt ratios are in danger of becoming insolvent or going bankrupt. Lenders pay especially close attention to this ratio.

How much net profit your business is producing can be determined by calculating your profit margin.

Profit margin = Net income/Gross sales

If a business’s gross sales are $180,980 and its net income is $42,325, its profit margin is:

$42,325 / $180,980 = 23.4%

So for every dollar in gross sales, this business is generating a little more than 23 cents net profit. Obviously, the higher the profit margin, the better off the business, but the profit margin also is useful to measure how a business is performing over time.

At a glance, you can see whether your business’s net profit has increased, stayed the same, or decreased over last year. And if it’s decreased, you’ll know to take steps to cure the problem, such as better controlling your expenses .

Imagine the ratios in the examples above belonging to a single business, and you can see how just calculating these three ratios can provide a quick health check for your business. The business in the example isn’t at death’s door yet, but it is ailing. While the profit margin and current assets ratio are robust, the total debt ratio shows that the business is carrying too much debt, which will interfere with cash flow if it hasn’t already.

If your business is incorporated, the debt-to-equity ratio is an important measure of the total amount of debt (current and long term liabilities) carried by the business vs. the amount invested by the shareholders.

If a business's total liabilities are $500,000 and the shareholder's equity is $600,000 the debt-to-equity is:

$500,000 / $600,000 = 0.83

In other words, the portion of assets provided by the shareholders is greater than that provided by creditors, which typically is a good sign.

If your business needs debt or equity financing, the debt-to-equity ratio will be closely scrutinized by lenders or investors. The higher the ratio, the higher the risk carried by the business.

Debt-to-equity ratios are benchmarked by industry. Capital-intensive industries such as transportation and utilities tend to have higher ratios (2.0 or more) while industries such as insurance carriers usually have ratios lower than 0.5.

What is the current ratio?

• Calculation

How to interpret the current ratio

• Its role in financial analysis 
• Factors influencing the current ratio 
• Limitations

Enhancing financial strategy with the current ratio

Understanding the current ratio.

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• The current ratio measures a company's capacity to pay its short-term liabilities due in one year.
• The current ratio weighs a company's current assets against its current liabilities.
• A good current ratio is typically considered to be anywhere between 1.5 and 3.

When determining a company's solvency 一 the ability to pay its short-term obligations using its current assets 一 you can use several accounting ratios. The current ratio is one of them. The current ratio is a measure used to evaluate the overall financial health of a company. Here's how it works and how to calculate it.

Definition and significance 

The current ratio, sometimes referred to as the working capital ratio, is a metric used to measure a company's ability to pay its short-term liabilities, or those due within a year. In other words, it shows how a company can maximize current assets to settle its short-term obligations.

"The current ratio is simply current assets divided by current liabilities. A higher ratio indicates a higher level of liquidity," says Robert Johnson, a CFA and professor of finance at Creighton University Heider College of Business .

When you calculate a company's current ratio, the resulting number determines whether it's a good investment. A company with a current ratio of less than 1 has insufficient capital to meet its short-term debts because it has a larger proportion of liabilities relative to the value of its current assets.

On the other hand, a company with a current ratio greater than 1 will likely pay off its current liabilities since it has no short-term liquidity concerns. An excessively high current ratio, above 3, could indicate that the company can pay its existing debts three times. It could also be a sign that the company isn't effectively managing its funds.

The current ratio can help determine if a company would be a good investment. But since the current ratio changes over time, it may not be the best determining factor for which company is a good investment. This is because a company facing headwinds now could be working toward a healthy current ratio and vice versa. 

Calculating the current ratio 

Formula and components .

The current ratio is calculated using two common variables found on a company's balance sheet: current assets and current liabilities. This is the formula:

The resulting figure represents the number of times a company can pay its current short-term obligations with its current assets.  

Current assets

Current assets are all the assets listed on a company's balance sheet expected to be converted into cash, used, or exhausted within an operating cycle lasting one year. Current assets include cash and cash equivalents, marketable securities, inventory, accounts receivable, and prepaid expenses. 

Current liabilities 

Current liabilities are a company's short-term obligations due and payable in one year. Common current liabilities found on the balance sheet include short-term debt, accounts payable, dividends owed, accrued expenses, income taxes outstanding, and notes payable.

Current ratio example

Let's take a look at a real-life example of how to calculate the current ratio based on the balance sheet figures of Amazon for the fiscal year ending 2019. The current assets of the retail giant stood at $96.3 billion and current liabilities at $87.8 billion.

To calculate the current ratio, you divide the current assets by current liabilities. So the current ratio for Amazon will be 1.1, meaning the company has at least enough assets to pay off its short-term obligations.

What different values indicate 

Some companies in specific industries may have a current ratio below 1, while others may exceed 3. Food services and retail, for example, may be more likely than other industries to have companies that quickly collect revenue from customers but take far longer to reimburse their suppliers, which could result in them having a current ratio below 1. 

"A good current ratio is really determined by industry type, but in most cases, a current ratio between 1.5 and 3 is acceptable," says Ben Richmond, US country manager at Xero . This means that the value of a company's assets is 1.5 to 3 times the amount of its current liabilities.

Note: A highly excessive current ratio typically above 3 doesn't necessarily mean a company is a good investment. It could mean that the company has problems managing its capital allocation effectively.    

Another factor that may influence what constitutes a "good" current ratio is who is asking. While an investor may interpret a current ratio of 3 or higher as pointing to operational inefficiencies, a lender might look favorably upon such a ratio, considering it a strong signal that the company in question can pay its debts. 

The role of the current ratio in financial analysis 

Assessing company liquidity.

The current ratio is one tool you can use to analyze a company and its financial state. An interested investor might also want to look at other key considerations like an organization's profit margins and quick ratio, for example. 

The current ratio, in particular, is one way to evaluate a company's liquidity, specifically the ease with which they can cover their short-term obligations. However, it is not the only ratio an interested party can use to evaluate corporate liquidity. 

Comparing with other liquidity ratios  

Current ratio vs. quick ratio  

Another ratio, which is similar to the current ratio and can be used as a liquidity measure, is the quick ratio . Both give a view of a company's ability to meet its current obligations should they become due, though they do so with different time frames in mind.

The current ratio evaluates a company's ability to pay its short-term liabilities with its current assets. The quick ratio measures a company's liquidity based only on assets that can be converted to cash within 90 days or less.

The key difference between the two liquidity ratios is that the quick ratio only considers assets that can be quickly converted into cash, while the current ratio takes into account assets that generally take more time to liquidate. In other words, "the quick ratio excludes inventory in its calculation, unlike the current ratio," says Johnson. 

Current ratio vs. cash ratio

Another ratio interested parties can use to evaluate a company's liquidity is the cash ratio. The cash ratio is like the current ratio, except it only considers a company's most liquid assets in evaluating its liquidity. 

More specifically, the current ratio is calculated by taking a company's cash and marketable securities and then dividing this value by the organization's liabilities. This approach is considered more conservative than other similar measures like the current ratio and the quick ratio. 

Factors influencing the current ratio 

Variability in asset composition .

Potential investors leveraging the current ratio should keep in mind that the assets of companies can vary quite a bit, and businesses with significantly different asset compositions can end up with the same current ratio. 

For example, a company's inventory, which can prove difficult to liquidate, could account for a substantial fraction of its assets. Since this inventory, which could be highly illiquid, counts just as much toward a company's assets as its cash, the current ratio for a company with significant inventory can be misleading. 

Seasonal and industry impacts

Businesses may experience fluctuations in their current ratio as a result of seasonal changes. For example, a retail business may have a higher level of inventory during the holiday season, which could impact its ratio of assets to liabilities. Further, a company may need to borrow more during slow seasons to fund its operations, which could also impact the current ratio. 

Limitations of the current ratio

Potential for misinterpretation .

The current ratio has several limitations that could cause it to be misinterpreted. It is crucial to keep this in mind when using the current ratio for investment decisions. As noted earlier, variations in asset composition can cause the current ratio to be misleading. 

Another consideration is differences between industries. The current ratio may not be particularly helpful in evaluating companies across different industries, but it might be a more effective tool in analyzing businesses within the same industry. 

Some industries may collect revenue on a far more timely basis than others. Restaurants, for example, collect revenue from customers the day of. However, other industries might extend credit to customers and give them far more time to pay. If a company's accounts receivables have significant value, this could give the organization a higher current ratio, which could in turn prove misleading. 

The need for contextual analysis 

An investor looking to use the current ratio in evaluating a potential investment should keep in mind that the aforementioned ratio is just a starting point, and doing further research could be quite useful in gaining a more detailed, nuanced view of a business's financial health. 

Being familiar with this consideration is crucial when it comes to interpreting current ratio values in finance. 

The current ratio measures a company's capacity to meet its current obligations, typically due in one year. This metric evaluates a company's overall financial health by dividing its current assets by current liabilities. 

A current ratio of 1.5 to 3 is often considered good. However, when evaluating a company's liquidity, the current ratio alone doesn't determine whether it's a good investment or not. It's therefore important to consider other financial ratios in your analysis.

The current ratio accounts for all of a company's assets, whereas the quick ratio only counts a company's most liquid assets. 

A current ratio above 1 signifies that a company has more assets than liabilities. It should at least be able to cover its liabilities in the short-term. 

A very high current ratio could mean that a company has substantial assets to cover its liabilities. However, it could also mean that a business is not using its resources effectively.  

Seasonal businesses can experience substantial fluctuations in their current ratio. This figure can be interpreted through the lens of where a company is in its operating cycle. 

The current ratio can vary widely between industries, and companies within an industry follow certain patterns that can make the ratio a far more useful tool for comparison. 

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