What is the current ratio? (2024)

FAQs

What does current ratio explain? ›

The current ratio is a comparison of a company's current assets to current liabilities that can be used to find its liquidity, usually as a comparison between companies in the same industry. Potential creditors use the current ratio to measure a company's ability to pay off short-term debt.

The current ratio measures a company's capacity to pay its short-term liabilities due in one year. The current ratio weighs a company's current assets against its current liabilities. A good current ratio is typically considered to be anywhere between 1.5 and 3.

For example, if a company has a current ratio of 1.5—meaning its current assets exceed its current liabilities by 50%—it is in a relatively good position to pay off short-term debt obligations. Conversely, if the company's ratio is 0.8 or less, it may not have enough liquidity to pay off its short-term obligations.

Current Ratio

The current liabilities refer to the business' financial obligations that are payable within a year. Obviously, a higher current ratio is better for the business. A good current ratio is between 1.2 to 2, which means that the business has 2 times more current assets than liabilities to covers its debts.

A current ratio lower than one indicates risk and makes it hard for a company to meet its short-term obligations. Anything less than one means that a company has more current liabilities than its current assets. For example, a ratio of 0.5 means a company has twice its current liabilities than its current assets.

The current ratio for Company ABC is 2.5, which means that it has 2.5 times its liabilities in assets and can currently meet its financial obligations Any current ratio over 2 is considered 'good' by most accounts.

A good current ratio is considered 1.5 and above, though ratios between 1.2 and 1.5 can still be adequate for businesses in certain industries, such as industrial companies. On the other hand, if a company's ratio is 1.0 or lower, that signals financial distress requiring immediate attention.

The higher the ratio is, the more capable you are of paying off your debts. If your current ratio is low, it means you will have a difficult time paying your immediate debts and liabilities. In general, a current ratio of 2 or higher is considered good, and anything lower than 2 is a cause for concern.

Cash Ratio: 0.75

Because it's the simplest and most commonly used, let's focus on the current ratio. Generally speaking, you want to aim for a number a bit above 1.0. Anything below 1.0 indicates that your business might have trouble meeting its obligations.

Walmart has a current ratio of 0.80. It indicates that the company may have difficulty meeting its current obligations. Low values, however, do not indicate a critical problem. If Walmart has good long-term prospects, it may be able to borrow against those prospects to meet current obligations.

What is a weakness of the current ratio? ›

A weakness of the current ratio is that it doesn't take into account the composition of the current assets. the difficulty of the calculation. that it is rarely used by sophisticated analysts. that it can be expressed as a percentage, as a rate, or as a proportion.

If the company's current ratio is too high it may indicate that the company is not efficiently using its current assets or its short-term financing facilities. If current liabilities exceed current assets the current ratio will be less than 1.