current ratio

Fin

a ratio of current assets to current liabilities, used to measure a company’s liquidity and its ability to meet its short-term debt obligations.

EXAMPLE

The current ratio formula is a simple one:

Current assets/Current liabilities = Current ratio

Current assets are the ones that a company can turn into cash within 12 months during the ordinary course of business. Current liabilities are bills due to be paid within the coming 12 months.

     For example, if a company’s current assets are $300,000 and its current liabilities are $200,000, its current ratio would be:

300,000/200,000 = 1.5

As a rule of thumb, the 1.5 figure means that a company should be able to get hold of $1.50 for every $1.00 it owes.

     The higher the ratio, the more liquid the company. Prospective lenders expect a positive current ratio, often of at least 1.5. However, too high a ratio is cause for alarm too, because it indicates declining receivables and/or inventory—which may mean declining liquidity.

Also known as working capital ratio