1. Liquidity Measurement Ratios: Introduction
  2. Liquidity Measurement Ratios: Current Ratio
  3. Liquidity Measurement Ratios: Quick Ratio
  4. Liquidity Measurement Ratios: Cash Ratio
  5. Liquidity Measurement Ratios: Cash Conversion Cycle

The current ratio measures the ability of a company to cover its short-term liabilities with its current assets.

The formula is:

  • Current assets divided by current liabilities

As an example, a company with $10 million in current assets and $5 million in current liabilities would have a current ratio of 2.0 times.

A current ratio of 1.0 or greater is an indication that the company is well-positioned to cover its current or short-term liabilities.

A current ratio of less than 1.0 could be a sign of trouble if the company runs into financial difficulty.

Cautions in using this ratio

When looking at the current ratio, investors should be aware that this is not the whole story on company liquidity. It’s also important to understand the types of current assets the company has and how quickly these can be converted into cash to meet current liabilities.

For example, how quickly can the company collect all of its outstanding accounts receivables? An analyst would want to look at the company’s days sales outstanding which is a measure of how long it takes the company to receive payment after a sale is made.

For companies with inventory, how quickly can this inventory be liquidated should the need arise and what percentage of the inventory’s value would the company be likely to receive? Looking at the company as a going concern, an analyst would want to calculate the company’s inventory turnover ratio, a measurement of how long it takes a company to turnover or sell its inventory.

The current ratio inherently assumes that the company would or could liquidate all of most of its current assets and convert them to cash to cover these liabilities. In reality this is unlikely if the company is to remain as a going concern. A certain level of working capital will still be needed.

Companies with a seemingly high current ratio may not be safer than a company with a relatively low current ratio. Beyond just looking at the current ratio, an analyst would need to look at the composition and quality of the company’s current assets. The current ratio is just one of many financial indicators that potential investors and creditors will need to analyze.


Liquidity Measurement Ratios: Quick Ratio
Related Articles
  1. 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.
  2. 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.
  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

    Useful Balance Sheet Metrics

    These metrics can help you better understand the information found on balance sheets.
  5. 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.
  6. 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.
  7. Investing

    Financial Analysis: Solvency vs. Liquidity Ratios

    Solvency and liquidity are equally important for a company's financial health.
  8. Investing

    Analyze Investments Quickly With Ratios

    Make informed decisions about your investments with these easy equations.
Frequently Asked Questions
  1. Is There a Difference Between the Equity Market and the Stock Market?

    Equities and stocks refer to the same thing.
  2. What Happens to a Company's Stock When it Goes Bankrupt?

    Shareholders may be entitled to a portion of the liquidated assets in the wake of a bankrutpcy, but the stock will be worthless.
  3. What are Advantages and Disadvantages of Preference Shares?

    Preference shares have advantages and disadvantages for both investors and issuing companies.
  4. When am I eligible to receive Social Security benefits?

    Understand when you are eligible to begin collecting Social Security retirement benefits and how retiring at different ages ...
Trading Center