Loading the player...
A:

The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability to pay short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The current ratio is calculated by dividing current assets by current liabilities:

Current ratio = current assets / current liabilities

As of March 31, 2014, for example, Microsoft’s (MSFT) balance sheet listed the following:

Current Assets:

Cash and cash equivalents

$11,572,000

Short-term investments

$76,853,000

Net receivables

$14,921,000

Inventory

$1,920,000

Other current assets

$3,740,000

Total current assets

$109,006,000

Current Liabilities:

Accounts payable

$9,958,000

Short-term debt

$2,000,000

Other current liabilities

$21,945,000

Total current liabilities

$33,903,000

To determine MSFT’s current ratio, we divide current assets by current liabilities:

MSFT current ratio = $109,006,000 / $33,903,000 = 3.22

The current ratio can provide investors and analysts with clues about the efficiency of a company’s operating cycle or its ability to monetize its products. The higher the ratio, the more able a company is to pay off its obligations. While acceptable ratios vary depending on the specific industry, a ratio between 1.5 and 3 is generally considered healthy. Investors and analysts would consider MSFT, with a current ratio of 3.22, financially healthy and capable of paying off its obligations.

Liquidity problems can arise for companies that have difficulty getting paid on their receivables or that have slow inventory turnover because they can’t satisfy their obligations. A ratio under 1 implies that a company would be unable to pay off its obligations if they become due at that point in time. A ratio under 1 does not necessarily mean that a company will go bankrupt since it may be able to secure other forms of financing; however, it does indicate the company is not in good financial health. A ratio that is too high may indicate that the company is not efficiently using its current assets or short-term financing.

As with other financial ratios, it is more useful to compare various companies within the same industry than to look at only one company, or to attempt to compare companies from different industries. In addition, investors should consider more than one ratio (or number) when making investment decisions since one cannot provide a comprehensive view of the company.

RELATED FAQS
  1. How can the current ratio be misinterpreted by investors?

    Statistics can be misleading, and numbers on the balance sheet are no exception. Find out how the current ratio can confuse ... Read Answer >>
  2. What are the main differences between the current ratio and the quick ratio?

    Find out how the quick ratio and the current ratio can offer different views on a company's ability to pay off liabilities. Read Answer >>
  3. What are some alternative liquidity ratios to the cash ratio?

    Learn what the cash ratio measures, and understand what two other liquidity ratios can be used by a company to replace the ... Read Answer >>
  4. How can a company quickly increase its liquidity ratio?

    Discover what high and low values in the liquidity ratio mean and what steps companies can take to improve liquidity ratios ... Read Answer >>
  5. What is the formula for calculating the current ratio in Excel?

    Understand the basics of the current ratio, including its use and interpretation as a financial metric and how it is calculated ... Read Answer >>
  6. What is the relationship between the cash ratio and liquidity?

    Understand the relationship between a company's cash ratio and its liquidity. Learn what the cash ratio measures and what ... Read Answer >>
Related Articles
  1. Markets

    Do Your Investments Have Short-Term Health?

    If a company is strong enough to survive tough times, it is more likely to provide long-term value.
  2. Markets

    Dynamic Current Ratio: What It Is And How To Use It

    Learn why this ratio may be a good alternative to the current, cash and quick ratios.
  3. Trading

    Ratio Analysis

    Ratio analysis is the use of quantitative analysis of financial information in a company’s financial statements. The analysis is done by comparing line items in a company’s financial ...
  4. Investing

    5 Basic Financial Ratios And What They Reveal

    Understanding financial ratios can help investors pick strong stocks and build wealth. Here are five to know.
  5. Investing

    Financial Ratios to Spot Companies Headed for Bankruptcy

    Obtain information about specific financial ratios investors should monitor to get early warnings about companies potentially headed for bankruptcy.
  6. Markets

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  7. Markets

    What is the Cash Ratio?

    The cash ratio is the ratio of a company's total cash and cash equivalents to its current liabilities.
  8. Investing

    Current Liabilities

    Current Liabilities are company debts due within one year or one operating cycle, whichever is greater. An operating cycle is the time it takes a company to purchase inventory and convert it ...
  9. Investing

    Financial Analysis: Solvency Vs. Liquidity Ratios

    Solvency and liquidity are equally important for a company's financial health. A number of financial ratios are used to measure a company’s liquidity and solvency, and an investor should use ...
  10. Investing

    Key Financial Ratios to Analyze Tech Companies

    Understand the technology industry and the companies that operate in it. Learn about the key financial ratios used to analyze tech companies.
RELATED TERMS
  1. Current Ratio

    The current ratio is a liquidity ratio measuring a company's ...
  2. Cash Asset Ratio

    The current value of marketable securities and cash, divided ...
  3. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. ...
  4. Liquidity Ratios

    A class of financial metrics that is used to determine a company's ...
  5. Cash Ratio

    The ratio of a company's total cash and cash equivalents to its ...
  6. Efficiency Ratio

    Ratios that are typically used to analyze how well a company ...
Hot Definitions
  1. AAA

    The highest possible rating assigned to the bonds of an issuer by credit rating agencies. An issuer that is rated AAA has ...
  2. GBP

    The abbreviation for the British pound sterling, the official currency of the United Kingdom, the British Overseas Territories ...
  3. Diversification

    A risk management technique that mixes a wide variety of investments within a portfolio. The rationale behind this technique ...
  4. European Union - EU

    A group of European countries that participates in the world economy as one economic unit and operates under one official ...
  5. Sell-Off

    The rapid selling of securities, such as stocks, bonds and commodities. The increase in supply leads to a decline in the ...
  6. Brazil, Russia, India And China - BRIC

    An acronym for the economies of Brazil, Russia, India and China combined. It has been speculated that by 2050 these four ...
Trading Center