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

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 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 >>
  3. 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 >>
  4. 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 >>
  5. 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 >>
  6. To what extent should you take a company's liquidity ratio into account before investing ...

    Find out how important it is for an investor to know a company's liquidity ratio before deciding to invest, and why relying ... 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’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

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
  6. 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.
  7. 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.
  8. 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.
  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 ...
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. Working Capital Management

    A managerial accounting strategy focusing on maintaining efficient ...
Hot Definitions
  1. Frexit

    Frexit – short for "French exit" – is a French spinoff of the term Brexit, which emerged when the United Kingdom voted to ...
  2. Stop-Limit Order

    An order placed with a broker that combines the features of stop order with those of a limit order. A stop-limit order will ...
  3. Down Round

    A round of financing where investors purchase stock from a company at a lower valuation than the valuation placed upon the ...
  4. Keynesian Economics

    An economic theory of total spending in the economy and its effects on output and inflation. Keynesian economics was developed ...
  5. Portfolio Investment

    A holding of an asset in a portfolio. A portfolio investment is made with the expectation of earning a return on it. This ...
  6. Treynor Ratio

    A ratio developed by Jack Treynor that measures returns earned in excess of that which could have been earned on a riskless ...
Trading Center