Learn about the Current Ratio: definition, calculation, interpretation, and importance in assessing liquidity.
The Current Ratio is a commonly used liquidity ratio that measures a company's ability to pay off its short-term debts using its current assets. It calculates the proportion of current assets to current liabilities and indicates whether a company has enough resources to meet its short-term obligations.
The formula for the current ratio is:
Current Ratio = Current Assets / Current Liabilities
Current assets refer to assets that can be easily converted into cash within one year, such as cash, marketable securities, accounts receivable, and inventory. Current liabilities are debts that are due to be paid within one year, such as short-term loans, accounts payable, and wages payable.
A current ratio of 1:1 means that a company has exactly enough current assets to pay off its current liabilities. A ratio higher than 1 indicates that the company has more current assets than liabilities, while a ratio lower than 1 suggests that the company may have trouble meeting its short-term obligations. The ideal current ratio varies depending on the industry, but a general rule of thumb is to aim for a ratio of 2:1 or higher.