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

On 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. Investing

### 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. Investing

### 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. Investing

### Ratio Analysis

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

7. Investing

### 6 Basic Financial Ratios And What They Reveal

These formulas can help you pick better stocks for your portfolio once you learn how to use them.
8. Investing

### What is the Cash Ratio?

The cash ratio is the ratio of a company's total cash and cash equivalents to its current liabilities.
9. 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 ...
10. Investing

### Key Financial Ratios for Retail Companies

Using the following liquidity, profitability and debt ratios, an investor can gather deeper knowledge of a retail company's short-term and long-term outlook.
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. ### Liquidity Ratios

A class of financial metrics that is used to determine a company's ...
4. ### Quick Ratio

The quick ratio is an indicator of a company’s short-term liquidity. ...
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. ### Fiduciary

A fiduciary is a person who acts on behalf of another person, or persons to manage assets.
2. ### Demonetization

Demonetization is the act of stripping a currency unit of its status as legal tender and is necessary whenever there is a ...
3. ### Investment

An asset or item that is purchased with the hope that it will generate income or appreciate in the future. In an economic ...
4. ### Redlining

The unethical practice whereby financial institutions make it extremely difficult or impossible for residents of poor inner-city ...
5. ### Nonfarm Payroll

A statistic researched, recorded and reported by the U.S. Bureau of Labor Statistics intended to represent the total number ...
6. ### Conflict Theory

A theory propounded by Karl Marx that claims society is in a state of perpetual conflict due to competition for limited resources. ...