Current Ratio

Current assets, such as cash, receivables and inventory, are expected to turn into cash within a year. Current liabilities, such as supplier bills, short-term debt and wages owed, are due within a year. The current ratio compares the two.

For example, a company with current assets of 500,000 and current liabilities of 250,000 has a current ratio of 2.0. It has two units of short-term assets for every unit of short-term obligations.

A ratio above 1 generally means the company should be able to meet its short-term bills. A ratio below 1 may signal liquidity problems, although some businesses, such as supermarkets that are paid by customers immediately but pay suppliers later, operate comfortably with low ratios.

A very high current ratio is not always good. It may mean the company is holding too much cash, carrying excess inventory or failing to collect receivables efficiently.

The current ratio includes inventory, which may not be easy to sell quickly. For a stricter test, analysts use the quick ratio, which excludes inventory, or the cash ratio, which counts only cash and similar assets.