What Is the Current Ratio?

The current ratio is a common 澳洲幸运5开奖号码历史查询:liquidity ratio used to judge whether or nꦡot a company can pay current obligations.

It tells investors and analysts if a company can maximize the 澳洲幸运5开奖号码历史查询:current assets on its balance sheet to🥃 meet its current debt payments and other payablꦍes due within a year.

A current ratioꦑ 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 financial distress or default by the company.

If a company has a very h♏igh current ratio compared with its peer group, it indicates that mana🐲gement 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. It is sometimes called the 澳洲幸运5开奖号码历史查询:working capital ratio.

Understanding the Current Ratio

Investors, analysts, and companies need to know whether a business cಌan pay what it owes.

The current ratio provides a measure of this capability by weighing current (short-term) liabilities (debts and payables) against current assets (cash, inventory, and receivables).

In many cases, a company with a current ratio of less than 1.00 would not have the capital on hand to meet its short-term financial obligations should they all come due at o❀nce.

A current ratio greater than 1.00 indicat💖es that the company has the financial resources to remain solvent in the short term.

This is useful information. However, because the current ratio is a snapshot of a particular moment in time, it is usually not considered a complete representation of a company’s short-term 澳洲幸运5开奖号码历史查询:liquidity or longer-term solvency.

For example, a company may have a very high current ratio, but its 澳洲幸运5开奖号码历史查询:accounts receivab𒉰le may be very aged, perhaps because its customers pay slowly, which may be hidden in the current ratio. Some of the accounts receivable may eve🧸n need to be written off.

Analysts also must consider the quality of a company’s other assets vs. its obligations. If the 澳洲幸运5开奖号码历史查询:inventory is unable to be sold, the current ratio may look acceptable even though the company may be headed for de𝄹fault.

In general, the higher the current ratio, the more capa💎ble a company is of paying its obligations. It has a larger proportion of short-term as♐set value relative to the value of its short-term liabilities.

Note though that a high ratio—say, more than 3.00—could indicate that although the company can cover its current liabilities three times, it may not be using its current assets efficiently, securing financing very well, or 澳洲幸运5开奖🅷号码历史查询:🐬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 th🌱e ratio, compare current assets to current liabilities.

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

Current assets listed on a company’s balance sheet include cash, accounts receivable, inventory, and other current assets (OCA) that are expected to ဣbe liquidated or tur꧃ned 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.

Using the Current Ratio

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 collectio🐽ns ebb.

Calculating the current ratio at 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 it💦s 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 liabili♚🔴ties, 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 regularly over several periods. That is, 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 thꦰat may appear to ♐be struggling now could be making good progress toward a healthier current ratio.

In the first case, the t𓂃rend of the cu𒊎rrent 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.

Example of Current Ratio

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

Company B

In thi🍒s 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 bei𒆙ng depleted, either of which could be a solvency issue if the trend worsens.

Company A

On the other hand, the trend for Company A is positive. This could indicate that the company has better collections, faster 澳洲幸运5开奖号码历史查询:inventory turnover, or simply a better abilit⛦y to pay down its dꦛebt.

The trend is also mor▨e 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 could 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 澳洲幸运5开奖号码历史查询:volatility.

There were wider swings from 2020 to 2021. This could mean the shorter-term resources are more inconsꦅistent, making the company perha🗹ps a bit riskier or more unpredictable.

Current Ratio vs. Other Liquidity Ratios

Similar liquidity ratios can supplement a current ratio analysis🌃. They 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 changiꦜng over time.

The commonly used 澳洲幸运5开奖号码历史查询:acid-test ratio, or 澳洲幸运5开奖号码历史查询:quick ratio, compares a company’s easily liquidated assets (including cash, accounts receivable, and short-term investments, and excluding invento𓄧ry and prepaid expenses) to its current liabilities.

The 澳洲幸运5开奖号码历史查询:cash asset ratio, or 澳洲幸运5开奖号码历史查询:cash ratio, also is similar to the current ratio, but it only compares a company’s marketa🥃ble securities and cash to its current liabilities.

Companies may use the days sales outstanding metric to better understand how long it takes for a company to collect payments after credit sales have beenཧ ෴made.

🦹While the current ratio looks at the liquidity of the company overall, days sales outstanding calculates liquidity specifically to determine how well a co🉐mpany collects outstanding accounts receivables.

Finally, the 澳洲幸运5开奖号码历史查询:operating cash flow ratio compares a company’s active 澳洲幸运5开奖号码历史查询:cash flow from oper🐼ating activities (CF🐓O) to its current liabilities. This allows a co𒆙mpany to better gauge funding capabilities by omitting implications created by accounting entries.

Limitations of the Current Ratio

One limitation of the current ratio emerge🐽s when using it to compare different companies wit🐓h one another.

Businesses differ substantially among industries; comparing the current ratios of companies across different industries may not lead tꦰo productive insight.

For example, in one industry, it may be more typical to 澳洲幸运5开奖号码历史查询:extend credit to clients for 90 days or longer, while in anothe༺r industry, short-term collections are more critical.

Ironically, the industry that ꦍextends more credit actually may have a superficially stronger current ratio because its current assets would be higher.

Another drawback of using tꦦhe current ratio involves its lack of specificity. Unlike other liquidity ratios, it incorporates all of a company꧑’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 o🍰f 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 baꦇlance sheet.

Company B has more cash, which is the most liquid asset, a🔴nd 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.

Also, the current liabilities of Company A and Company B are very different. Compa♍ny A has more accounts payable, while Company B has a greater amount in short-term notes payable.

This would be worth mꦆore 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 t🐻erm.

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 澳洲幸运5开奖号码历史查询:evaluating other liquidity ratios that are more narrowly focuജsed than the current r🍨atio.

The Bottom Line

The current ratio is a liquidity measurement used to track how easily a company can meet its short-term debt obligations. It compares current assets to current liabilities. Measurements of less than 1.0 indicate a company's potential inability to pay what it owes in the short term.

Since assets and liabilities change over time, it is helpful to calculate a current ratio from year to year to analyze whether it shows a positive or negative 🧔trend.