Current Ratio Guide: Definition, Formula, and Examples

I have compiled below the total current assets and total current liabilities of Thomas Cook. You may note that this ratio of Thomas Cook tends to move up in the September Quarter. Current ratio is equal to total current assets divided by total current liabilities. Dividing your total current assets by your total current liabilities determines how much of your current liabilities can be covered by your current assets. Unlike traditional bookkeeping, which relies on periodic updates, real-time bookkeeping ensures continuous transaction recording, automated reconciliation, and real-time financial reporting. This allows business owners to make faster, data-driven decisions, reduce errors, enhance tax compliance, and stay audit-ready.

The current ratio is most useful when measured over time, compared against a competitor, or compared against a benchmark. In the first case, the trend of the current ratio over time would be expected to harm the company’s valuation. Meanwhile, an improving current ratio could indicate an opportunity to invest in an undervalued stock amid a turnaround. For example, a normal cycle for the company’s collections and payment processes may lead to a high current ratio as payments are received, but a low current ratio as those collections ebb. Seasonality is normally seen in seasonal commodity-related businesses where raw materials like sugar, wheat, etc., are required.

Example 1: Company A

For example, the debt-to-equity ratio can provide insight into a company’s long-term debt obligations. In contrast, the return on equity can provide insight into how effectively a company uses its assets to generate profits. Let’s say that Company E had a current ratio of 1.5 last year and a current ratio of 2.0 this year. This suggests that Company E has improved its ability to pay its short-term debts and obligations over the past year. While Company D has a lower current ratio than Company C, it may not necessarily be in worse financial health. The retail industry typically has high inventory levels, which can increase a company’s current assets and current ratio.

• For example, the quick ratio is another financial metric that measures a company’s ability to meet its short-term obligations.
• This gives you a more accurate and complete view of your company’s financial health and an opportunity to identify areas for growth.
• For example, a recession may lead to lower sales and slower collections, impacting a company’s ability to meet its short-term obligations.
• You can find these details on the company’s balance sheet, usually under the “Current Assets” section.
• A good current ratio like this suggests that ABC Corp is in a solid liquidity position, capable of covering its short-term obligations without significant financial strain.

They may borrow from suppliers (increasing accounts payable) and actually receive payment from their customers before the money is due to those suppliers. In this case, a low current ratio reflects Walmart’s strong competitive position. If we swap these and say that you have $100,000 in current assets and $200,000 in current liabilities, the current ratio is 0.5 now. This means that you’d be able to pay off about half of your current liabilities if all current assets were liquidated. On the other hand, if it is greater than 1, the company will likely pay off its current liabilities since it has no short-term liquidity concerns.

A company with a high current ratio may be viewed as less risky and may have an easier time securing loans and credit. Investors and stakeholders can use the current ratio to make investment decisions. A company with a high current ratio may be considered a safer investment than one with a low current ratio, as it can better meet its short-term debt obligations.

• This result shows that ABC Corp has $1.50 in current assets for every $1 of current liabilities.
• While the current ratio looks at the liquidity of the company overall, days sales outstanding calculates liquidity specifically to determine how well a company collects outstanding accounts receivables.
• It is important to note that the current ratio is just one of many financial metrics that should be considered when evaluating a company’s financial health.
• It essentially calculates the total profit a company generates from its sales and revenue or the amount of net profit it earns per dollar of revenue earned.
• Therefore, applicable to all measures of liquidity, solvency, and default risk, further financial due diligence is necessary to understand the real financial health of our hypothetical company.

Investors and stakeholders can use this comparison to evaluate a company’s performance relative to its peers and identify potential areas for improvement. The current ratio helps investors and stakeholders assess a company’s financial risk by measuring its ability to pay off short-term debts. A low current ratio may indicate a company’s difficulty meeting its short-term obligations, which can be a red flag for investors and stakeholders.

A high current ratio suggests that a company has a strong ability to meet its short-term obligations. Other measures of liquidity and solvency that are similar to the current ratio might be more useful, depending on the situation. For instance, while the current ratio takes into account all of a company’s current assets and liabilities, it doesn’t account for customer and supplier credit terms, or operating cash flows.

The following data has been extracted from the financial statements of two companies – company A and company B. This is markedly different from Company B’s current ratio, which demonstrates a higher level of volatility. It could be a sign that the company is taking on too much debt or that its cash balance is being depleted, either of which could be a solvency issue if the trend worsens. You can calculate the average inventory by adding the opening and closing inventory over a specified period and dividing the sum by 2. With that said, the required inputs can be calculated using the following formulas. InvestingPro offers detailed insights into companies’ Current Ratio including sector benchmarks and competitor analysis.

What is Economic Profit? Understanding True Business Performance Beyond Accounting Numbers

The current ratio is a liquidity measurement used to track how easily a company can meet its short-term debt obligations. Measurements of less than 1.0 indicate a company’s potential inability to pay what it owes in the short term. The current ratio is just one of several liquidity today is the tax deadline metrics used to evaluate a company’s financial health. Comparing it with other metrics can provide a deeper understanding of a company’s ability to handle its short-term obligations and maintain operational efficiency. One of the simplest ways to improve a company’s current ratio is to increase its current assets. This can be achieved by increasing cash reserves, accelerating accounts receivable collections, or reducing inventory levels.

Size of the Company – How Does the Industry in Which a Company Operates Affect Its Current Ratio?

Because buildings aren’t considered current assets, and the project ate through cash reserves, the current ratio could fall below 1.00 until more cash is earned. In many cases, a company with a current ratio of less than 1.00 would not have the capital on hand to meet its short-term financial obligations should they all come due at once. In comparison to the current ratio, the quick ratio is considered a more strict variation due to filtering out current assets that are not actually liquid — i.e. cannot be sold for cash immediately. Current ratio (also known as working capital ratio) is a popular tool to evaluate short-term solvency position of a business. Short-term solvency refers to the ability of a business to pay its short-term obligations when they become due. Short term obligations (also known as current liabilities) are the liabilities payable within a short period of time, usually one year.

Industry variations:

CFI is the global institution behind the financial modeling and valuation analyst FMVA® Designation. CFI is on a mission to enable anyone to be a great financial analyst and have a great career path. In order to help you advance your career, CFI has compiled many resources to assist you along the path. For example, in one industry, it may be more typical to extend credit to clients for 90 days or longer, while in another industry, short-term collections are more critical.

Current ratio vs. cash ratio

The bank may evaluate Company F’s current ratio to determine its ability to repay the loan. If Company F has a high current ratio, the bank may be more likely to extend credit, suggesting the company can meet its short-term obligations. Below is a video explanation of how to calculate the current ratio and why it matters when performing an analysis of financial statements. The current ratio is a common liquidity ratio used to judge whether or not a company can pay current obligations. The current ratio (CR) is one of the first things that accountants and investors will look at when assessing the health of your business, then determine whether it’s a good investment.

Current ratio, also known as working capital ratio, shows a company’s current assets in proportion to its current liabilities. The current ratio is a widely used working capital ratio that is used by businesses to keep their liquidity within favorable limits. In this article, you’ll know what a healthy current ratio looks like and how to calculate it for your business.

For example, long-term investments or loans should not be included in the calculation. Accurate classification is important to ensure that the financial statements reflect only the items that are expected to be settled or converted within a year. While a ratio above 1 typically indicates financial stability, it’s also important to consider industry standards and the nature of the company’s operations for a complete analysis.