# Current Ratio Explained With Formula and Examples

> **Definition**
>
> The current ratio compares current assets to current liabilities to determine how well a company can meet all financial obligations due within a year.

## What Is the Current Ratio?

The current ratio is a common [liquidity ratio](https://www.investopedia.com/terms/l/liquidityratios.asp) used to judge whether or not a company can pay current obligations.

It tells investors and analysts if a company can maximize the [current assets](https://www.investopedia.com/terms/c/currentassets.asp) on its balance sheet to meet its current debt payments and other payables due within a year.

A current ratio 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 high current ratio compared with its peer group, it indicates that management 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 [working capital](https://www.investopedia.com/terms/w/workingcapital.asp) ratio.

### Key Takeaways

*   The current ratio divides all of a company’s current assets by its current liabilities.
*   The current ratio helps investors understand a company’s ability to cover its short-term debt and bills.
*   It can be used to compare a company to its competitors and peers.
*   Industries have different expected or average current ratios, so it shouldn't be used to compare companies in different industries.
*   Others limitations include the overgeneralization of the specific asset and liability balances, as well as the lack of trending information.

![Current Ratio](https://www.investopedia.com/thmb/sHBECCSRDfhtaqet7ytsDQ5FTMc=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/Current_Ratio-eb91b25d3dcb46439d4f733dc19d0a0f.png)

*Investors and lenders also use the current ratio as an indicator of a company's financial health and risk profile. — Investopedia / Lara Antal*

## Understanding the Current Ratio

Investors, analysts, and companies need to know whether a business can 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 once.

A current ratio greater than 1.00 indicates 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 [liquidity](https://www.investopedia.com/terms/l/liquidity.asp) or longer-term [solvency](https://www.investopedia.com/terms/s/solvency.asp).

For example, a company may have a very high current ratio, but its [accounts receivable may be very aged](https://www.investopedia.com/terms/a/accounts-receivable-aging.asp), perhaps because its customers pay slowly, which may be hidden in the current ratio. Some of the accounts receivable may even need to be written off.

Analysts also must consider the quality of a company’s other assets vs. its obligations. If the [inventory is unable to be sold](https://www.investopedia.com/terms/o/obsoleteinventory.asp), the current ratio may look acceptable even though the company may be headed for default.

In general, the higher the current ratio, the more capable a company is of paying its obligations. It has a larger proportion of short-term asset 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 [properly managing its working capital](https://www.investopedia.com/ask/answers/071114/how-do-you-calculate-working-capital.asp).

This is why it is helpful to compare a company's current ratio to those of similarly-sized businesses within the same industry.

> **Important**
>
> Public companies don't report their current ratio, though all the information needed to calculate the it is contained in the company's financial statements.

## Formula and Calculation for the Current Ratio

To calculate the ratio, compare current assets to current liabilities.

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

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.

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 collections 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 its 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](https://www.investopedia.com/terms/s/supplychain.asp), which makes their current assets shrink against current liabilities, 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 that may appear to be struggling now could be making good progress toward a healthier current ratio.

In the first case, the trend of the current 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 level of risk, analysts would have different expectations for each company depending on how the current ratio of each had changed over time.

### Company B

In this 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 being 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 [inventory turnover](https://www.investopedia.com/terms/i/inventoryturnover.asp), or simply a better ability to pay down its debt.

The trend is also more 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 [volatility](https://www.investopedia.com/terms/v/volatility.asp).

There were wider swings from 2020 to 2021. This could mean the shorter-term resources are more inconsistent, making the company perhaps 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 changing over time.

The commonly used [acid-test ratio](https://www.investopedia.com/terms/a/acidtest.asp), or [quick ratio](https://www.investopedia.com/terms/q/quickratio.asp), compares a company’s easily liquidated assets (including cash, accounts receivable, and short-term investments, and excluding inventory and prepaid expenses) to its current liabilities.

The [cash asset ratio](https://www.investopedia.com/terms/c/cash-asset-ratio.asp), or [cash ratio](https://www.investopedia.com/terms/c/cash-ratio.asp), also is similar to the current ratio, but it only compares a company’s marketable 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 been made.

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

Finally, the [operating cash flow ratio](https://www.investopedia.com/terms/o/ocfratio.asp) compares a company’s active [cash flow from operating activities (CFO)](https://www.investopedia.com/terms/c/cash-flow-from-operating-activities.asp) to its current liabilities. This allows a company to better gauge funding capabilities by omitting implications created by accounting entries.

## Limitations of the Current Ratio

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.

For example, in one industry, it may be more typical to [extend credit](https://www.investopedia.com/terms/t/trade-credit.asp) to clients for 90 days or longer, while in another industry, short-term collections are more critical.

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

> **Tip**
>
> The current ratio is most useful when measured over time, compared against a competitor, or compared against a benchmark.

Another drawback of using the current ratio involves its lack of specificity. Unlike other liquidity ratios, it incorporates all of a company’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](https://www.investopedia.com/terms/q/quarter.asp). On the surface, this may look equivalent, but the quality and liquidity of those assets may be very different:

![Image](https://www.investopedia.com/thmb/zdOb_4iiMpSxRxnZXnqiDQFqwyQ=/1500x0/filters:no_upscale():max_bytes(150000):strip_icc()/dotdash_Final_Current_Ratio_Jul_2020-03-54eeb2ed66a546ad8c2f1e5e86366170.jpg)

**

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 balance sheet.

Company B has more cash, which is the most liquid asset, and 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. Company A has more accounts payable, while Company B has a greater amount in short-term notes payable.

This would be worth more 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 term.

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 [evaluating other liquidity ratios](https://www.investopedia.com/terms/d/defensive-interval-ratio.asp) that are more narrowly focused than the current ratio.

## What Is a Good Current Ratio?

That depends on the company’s industry and historical performance. Current ratios over 1.00 indicate that a company's current assets are greater than its current liabilities. This means that it could pay all of its short-term debts and bills. A current ratio of 1.50 or greater would generally indicate ample liquidity.

## What Happens If the Current Ratio Is Less Than 1.0?

As a general rule, a current ratio below 1.00 indicates that a company could struggle to meet its short-term obligations. If a company's current ratio is less than one, it may have more bills to pay than easily accessible financial resources with which to pay those bills.

## What Does a Current Ratio of 1.5 Mean?

A current ratio of 1.5 indicates that a company has $1.50 of current assets for every $1 of current liabilities. It appears to have more than enough to meet current obligations

## How Is the Current Ratio Calculated?

To calculate the current ratio, divide a company’s current assets by its current liabilities. Both are listed on a company's balance sheet. Current assets are those that can be converted into cash within one year, while current liabilities are obligations expected to be paid within one year. Current assets include cash, inventory, and accounts receivable. Current liabilities include accounts payable, wages payable, and the current portion of any scheduled interest or principal payment.

## 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.

> **Article Sources**
>
> 1.  Accounting Tools. "[Current Ratio Definition](https://www.accountingtools.com/articles/current-ratio)."