An improving current ratio could indicate an opportunity to invest in an undervalued stock in a company turnaround. You calculate your business’s overall current ratio by dividing your current assets by your current liabilities. The current ratio accounts for all of a company’s assets, whereas the quick ratio only counts a company’s most liquid assets. However, when evaluating a company’s liquidity, the current ratio alone doesn’t determine whether it’s a good investment or not. It’s therefore important to consider other financial ratios in your analysis. Another ratio, which is similar to the current ratio and can be used as a liquidity measure, is the quick ratio.

Current ratio formula

• Businesses differ substantially between industries, and so comparing the current ratios of companies across different industries may not lead to productive insight.
• Because buildings aren’t considered current assets, and the project ate through cash reserves, the current ratio could fall below 1.00 until more cash is earned.
• However, an examination of the composition of current assets reveals that the total cash and debtors of Company X account for merely one-third of the total current assets.

For example, in one industry, it may be more typical to extend credit to clients for 90 days or longer, while in another industry, short-term collections are more critical. Ironically, the industry that extends more abusive tax shelters and transactions credit actually may have a superficially stronger current ratio because its current assets would be higher. In this example, the trend for Company B is negative, meaning the current ratio is decreasing over time.

Current Ratio Formula

Measurements less than 1.0 indicate a company’s potential inability to use current resources to fund short-term obligations. In each case, the differences in these measures 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 changing over time. This is why it is helpful to compare a company’s current ratio to those of similarly-sized businesses within the same industry. The current ratio and quick ratios measure a company’s financial health by comparing liquid assets to current or pressing liabilities.

What is the formula for the Current Ratio?

If the current ratio computation results in an amount greater than 1, it means that the company has adequate current assets to settle its current liabilities. In the above example, XYZ Company has current assets 2.32 times larger than current liabilities. In other words, for every $1 of current liability, the company has $2.32 of current assets available to pay for it.

Comparing with other liquidity ratios

An excessively high current ratio, above 3, could indicate that the company can pay its existing debts three times. It could also be a sign that the company isn’t effectively managing its funds. A high current ratio is generally considered a favorable sign for the company. Creditors are more willing to extend credit to those who can show that they have the resources to pay obligations. However, a current ratio that is too high might indicate that the company is missing out on more rewarding opportunities. Instead of keeping current assets (which are idle assets), the company could have invested in more productive assets such as long-term investments and plant assets.

For example, a retail business may have a higher level of inventory during the holiday season, which could impact its ratio of assets to liabilities. Further, a company may need to borrow more during slow seasons to fund its operations, which could also impact the current ratio. For example, a company’s inventory, which can prove difficult to liquidate, could account for a substantial fraction of its assets.

Our team of reviewers are established professionals with decades of experience in areas of personal finance and hold many advanced degrees and certifications. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. Finance Strategists has an advertising relationship with some of the companies included on this website. We may earn a commission when you click on a link or make a purchase through the links on our site. All of our content is based on objective analysis, and the opinions are our own.

Investors can use this type of liquidity ratio to make comparisons with a company’s peers and competitors. Ultimately, the current ratio helps investors understand a company’s ability to cover its short-term debts with its current assets. Within the current ratio, the assets and liabilities considered often have a timeframe.

Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career. 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. So, a ratio of 2.65 means that Sample Limited has more than enough cash to meet its immediate obligations. Our writing and editorial staff are a team of experts holding advanced financial designations and have written for most major financial media publications.

In this case, current liabilities are expressed as 1 and current assets are expressed as whatever proportionate figure they come to. Generally, the assumption is made that the higher the current ratio, the better the creditors’ position due to the higher probability that debts will be paid when due. Like most performance measures, it should be taken along with other factors for well-contextualized decision-making. Current liabilities include accounts payable, wages, accrued expenses, accrued interest and short-term debt.

As the amount expires, the current asset is reduced and the amount of the reduction is reported as an expense on the income statement. Your ability to pay them is called “liquidity,” and liquidity is one of the first things that accountants and investors will look at when assessing the health of your business. Seasonal businesses can experience substantial fluctuations in their current ratio. This figure can be interpreted through the lens of where a company is in its operating cycle. A current ratio above 1 signifies that a company has more assets than liabilities. The current ratio may not be particularly helpful in evaluating companies across different industries, but it might be a more effective tool in analyzing businesses within the same industry.