Current Ratio

What is current ratio?

The current ratio is one form of liquidity ratio, which indicates a company’s ability to satisfy immediate debts. To calculate the current ratio, divide the company’s current assets by its current liabilities.

If a company’s current ratio measures greater than one, it indicates a lower likelihood of default relating to short-term debts, while a ratio lower than one suggests greater difficulty in paying those debts. As with any statistic, though, it’s important to view the current ratio in context. Looking at long-term trends for the company’s ratio and the current ratio of similarly positioned businesses in its industry can provide much greater insights into a company’s financial health and longevity. 

FAQs 

Is a higher or lower current ratio better?

Generally, a higher ratio is a sign that a company is better positioned to pay off its short-term obligations. A ratio that is exceedingly high, however, might give an indication that a company is not growing at an appropriate rate, or is otherwise underutilizing its assets.

What is a good current ratio?

Determining a good ratio varies from business to business, but generally speaking, a current ratio between 1 and 2 suggests a healthy company that will not be blindsided by its existing debts.

Are companies with a current ratio lower than 1 in financial trouble?

While a low current ratio is not particularly desirable, it’s hard to predict the future success of a business by this one metric alone. The current ratio can fluctuate, and without seeing a recent history of these changes for any particular company it’s hard to say whether the ratio is a clear-cut indicator of financial health.