What Is the Current Ratio? Formula and Definition

The current ratio, which is also called the working capital ratio, compares the assets a company can convert into cash within a year with the liabilities it must pay off within a year. It is one of a few liquidity ratios—including the quick ratio, or acid test, and the cash ratio—that measure a company’s capacity to use cash to meet its short-term needs. The current ratio is a useful 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, and measurements less than 1.0 indicate a company’s potential inability to use current resources to fund short-term obligations.

• It is especially bad because Walmart is a major retailer with most of its current assets tied up in inventory.
• Prepaid expenses can’t be accessed immediately to cover debts, and inventory takes time to sell.
• An excessively high current ratio, above 3, could indicate that the company can pay its existing debts three times.
• On the other hand, a tech company may have a lower current ratio due to its reliance on intangible assets, such as patents and intellectual property, which are not included in current assets.
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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. 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. 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. Some banks expect it to be a minimum of 1.17 depending upon the industry.

Working Capital Calculation Example

The same is applicable to other companies as well that have substantially higher current ratios in comparison to their industry peers. So it is always wise to compare the obtained current ratio to that of other companies in the same branch of industry. Its decreasing value over time may be one of the first signs of the company’s financial troubles (insolvency). If you need to sell off inventory quickly in order to cover a debt obligation, you may have to discount the value considerably to move the inventory. Inventory sold at a discount does not have the same value as the inventory book value on the balance sheet.

• It may lead to difficulties in obtaining financing and erode stakeholder confidence.
• You can obtain the exact values of particular factors of this equation from the company’s annual report (balance sheet).
• The current ratio can yield misleading results under the circumstances noted below.
• So it is always wise to compare the obtained current ratio to that of other companies in the same branch of industry.
• If a company’s current ratio falls below 1, it signifies a potential liquidity issue.

Current ratios can vary depending on industry, size of company, and economic conditions. The current ratio can yield misleading results under the circumstances noted below. Bankrate.com is an independent, advertising-supported publisher and comparison service. We are compensated in exchange for placement of sponsored products and services, or by you clicking on certain links posted on our site. Therefore, this compensation may impact how, where and in what order products appear within listing categories, except where prohibited by law for our mortgage, home equity and other home lending products. Other factors, such as our own proprietary website rules and whether a product is offered in your area or at your self-selected credit score range, can also impact how and where products appear on this site.

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The current ratio is one of many liquidity ratios that you can use to measure a company’s ability to meet its short-term debt obligations as they come due. The current ratio compares a company’s current assets to its current liabilities. Both of these are easily found on the company’s balance sheet, and it makes the current ratio one of the simplest liquidity ratios to calculate. 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.

Problems with the Current Ratio

In these cases, the company may not have had the chance to reduce the value of its inventory via a write-off, overstating what it thinks it may receive due to outdated market expectations. 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. You can find them on your company’s balance sheet, alongside all of your other liabilities.

Bankrate does not offer advisory or brokerage services, nor does it provide individualized recommendations or personalized investment advice. Investment decisions should be based on an evaluation of your own personal financial situation, needs, risk tolerance and investment objectives. 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. Suppose we’re tasked with analyzing the liquidity of a company with the following balance sheet data in Year 1. The quick ratio may also be more appropriate for industries where inventory faces obsolescence. In fast-moving industries, a company’s warehouse of goods may quickly lose demand with consumers.

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Again, current assets are resources that can quickly be converted into cash within a year or less. 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. The current ratio is a valuable financial ratio that assesses a company’s short-term liquidity position.

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. This includes all the goods and materials a business has stored for future use, like raw materials, unfinished parts, and 20+ professionally crafted freelance invoice templates unsold stock on shelves. Upgrading to a paid membership gives you access to our extensive collection of plug-and-play Templates designed to power your performance—as well as CFI’s full course catalog and accredited Certification Programs. Finally, if stock picking is not for you, you could try investing in ETFs or in futures markets.

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. 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. Google has a sufficient amount of current assets to cover its current liabilities.

Current Ratio

In this article, we will explore the concept of the current ratio and its formula. The current ratio will usually be easier to calculate because both the current assets and current liabilities amounts are typically broken out on external financial statements. The current ratio measures a company’s ability to pay current, or short-term, liabilities (debt and payables) with its current, or short-term, assets (cash, inventory, and receivables).

A current ratio below 1 indicates that the company’s current liabilities exceed its current assets, raising concerns about its ability to meet short-term obligations. This situation may indicate financial distress, and the company may face challenges in paying its suppliers, meeting payroll, or servicing short-term debt. The current ratio measures the ability of an organization to pay its bills in the near-term. The ratio is used by analysts to determine whether they should invest in or lend money to a business. A current ratio that is close to the industry average is usually considered an acceptable level of performance for a firm. However, a below-average ratio can be a sign of poor asset use, and possibly of assets that cannot be easily liquidated.

It’s also important for decision-makers in the business to better understand how they’re managing working capital. It’s ideal to use several metrics, such as the quick and current ratios, profit margins, and historical trends, to get a clear picture of a company’s status. Current liabilities include accounts payable, wages,  accrued expenses, accrued interest and short-term debt. Another practical measure of a company’s liquidity is the quick ratio, otherwise known as the “acid-test” ratio. 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. The range used to gauge the financial health of a company using the current ratio metric varies on the specific industry.