current ratio

The arithmetic ratio of current assets to liabilities.

A liquidity ratio that measures a company's ability to pay short-term obligations.

Calculated as:



Also known as "liquidity ratio", "cash asset ratio" and "cash ratio".

Investopedia Says:
The ratio is mainly used to give an idea of the company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the more capable the company is of paying its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. While this shows the company is not in good financial health, it does not necessarily mean that it will go bankrupt - as there are many ways to access financing - but it is definitely not a good sign.

The current ratio can give a sense of the efficiency of a company's operating cycle or its ability to turn its product into cash. Companies that have trouble getting paid on their receivables or have long inventory turnover can run into liquidity problems because they are unable to alleviate their obligations. Because business operations differ in each industry, it is always more useful to compare companies within the same industry.

This ratio is similar to the acid-test ratio except that the acid-test ratio does not include inventory and prepaids as assets that can be liquidated. The components of current ratio (current assets and current liabilities) can be used to derive working capital (difference between current assets and current liabilities). Working capital is frequently used to derive the working capital ratio, which is working capital as a ratio of sales.

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Measure of liquidity. Current assets are divided by current liabilities. Assuming current assets are $120,000 and current liabilities are $40,000 the current ratio is

The higher the current ratio, the more assurance that current liabilities can be paid. Thus, there is greater short-term creditor protection. (A company's ratio can be compared with the average in its industry to see whether it is high or low.) An excess of current assets over current liabilities is a buffer against losses that may occur in selling inventory, collecting accounts receivable, or liquidating current investment (e.g., marketable securities). A high current ratio provides a margin of safety against uncertainty and random fluctuations (e.g., strikes, extraordinary losses).

In general, a business with less inventory and more collectible accounts receivable can operate safely with a lower current ratio than a company having a high percentage of current assets in inventory.

Creditors looking at a company's current ratio must consider the quality of the current assets and the nature of the current liabilities. For example, work-in-process inventory has a higher realization risk than finished goods.