Definition
The current ratio is a measure of liquidity. The calculation only requires two inputs from the balance sheet: current assets and current liabilities. The current ratio measures a company's ability to pay debt coming due in the next 12 months.
Calculation
Current Ratio = Current Assets / Current Liabilities
Explanation
Current assets are those resources that can be converted into cash in less than 12 months. Current liabilities are the debt of the company that must be settled in cash over the next 12 months. The current ratio measures a company's ability to pay its debt coming due in the next 12 months. This is why the ratio is considered a measure of liquidity.
One of the ways to evaluate changes in working capital is to look at the relationship between current assets and current liabilities. Creditors would like to see a very high ratio (greater than 2.0). However, a ratio that is too high can indicate the inefficient use of capital resources.
When drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry.
Example
Company A's balance sheet indicates total current assets of $12,240,000 and total current liabilities of $5,441,000. The current ratio for Company A would then be:
= $12,240,000 / $5,441,000, or 2.25
Related Terms
- Also known as the acid test, the quick ratio is a measure of liquidity, which is the ability of a company to pay its short term debt obligations using a subset of current assets known as quick assets. The calculation of the quick ratio requires information found on a company's balance sheet.
Moneyzine EditorSeptember 21st, 2023 
A financial metric that is used to measure a company's ability to repay its short term debt obligations is called a liquidity ratio. The three most common liquidity ratios include the current, quick, and the cash ratio.Moneyzine EditorJanuary 23rd, 2024- The debt ratio is a simple indicator of the leverage used by a company. The debt ratio measures the proportion of the total assets that are financed by debt, and not by stockholders.Moneyzine EditorSeptember 19th, 2023
The cash ratio is a measure of liquidity. The calculation only requires three inputs from the balance sheet: cash, marketable securities, and current liabilities. The cash ratio is one of several measures used by investors to understand a company's ability to pay debt coming due in the next 12 months.Moneyzine EditorJanuary 10th, 2024.png)
The term liquidity is used to describe the relative time it takes until an asset is converted into cash, or the payment of a liability is due. Liquidity is a comparative term, meaning it may be easier to convert one asset into cash than another.Moneyzine EditorJanuary 23rd, 2024- The term defensive-interval ratio refers to a measure of the number of days a company can operate using only its current assets. The defensive-interval ratio is considered a measure of liquidity, since it evaluates a company's ability to meet its financial obligations.Moneyzine EditorSeptember 19th, 2023
.png)
