Current Ratio
Current Ratio = Current Assets / Current Liabilities
Measures a firm's ability to pay short-term obligations. A higher ratio means more liquidity cushion.
Variables
Cash, receivables, inventory due within one year
Obligations due within one year
Example Calculation
Scenario
A company has $500,000 in current assets and $250,000 in current liabilities.
Given Data
Calculation
Current Ratio = 500,000 / 250,000 = 2.0
Result
2.0
Interpretation
The firm has $2 in current assets for every $1 in current liabilities, indicating solid short-term liquidity.
When to Use This Formula
- ✓Assessing short-term solvency
- ✓Comparing liquidity across firms
- ✓Credit analysis
Common Mistakes
- ✗Treating a high ratio as always good (excess inventory inflates it)
- ✗Not comparing to industry benchmarks
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FAQs
Common questions about this formula
Generally 1.5 to 2.0, but it varies by industry. Retail may be lower; manufacturing may be higher.
The quick ratio excludes inventory from current assets, providing a more conservative liquidity measure. It is useful when inventory is slow-moving or hard to liquidate, such as in manufacturing or real estate.