What is the current ratio?
The current ratio is a current ratio that measures a company’s ability to pay short-term debt or debt due within one year. It tells investors and analysts how a company can maximize its current assets on its balance sheet to meet its current liabilities and other payables.
Current ratios that are in line with the industry average or slightly higher are generally considered acceptable. A current ratio below the industry average could indicate a higher risk of distress or default. Likewise, if a company’s current ratio is very high compared to its peers, it’s a sign that management may not be using its assets effectively.
The current ratio is called the current ratio because, unlike some other liquidity ratios, it includes all current assets and current liabilities. The current ratio is sometimes called the working capital ratio.
- The current ratio compares all of a company’s current assets with its current liabilities.
- These are generally defined as cash assets or assets that will turn into cash in a year or less and liabilities that will be paid in a year or less.
- The current ratio helps investors learn more about a company’s ability to service short-term debt with current assets, as well as make apples-to-apples comparisons with competitors and peers.
- Weaknesses of current ratios include difficulty in comparing measures across industry groups, overgeneralization of specific asset and liability balances, and a lack of trend information.
Formula and Calculation of Current Ratio
To calculate this ratio, analysts compare a company’s current assets to its current liabilities.
Current assets listed on a company’s balance sheet include cash, accounts receivable, inventory, and other current assets (OCAs) that are expected to be realized or turned into cash in less than a year.
Current liabilities include the current portion of accounts payable, wages, taxes payable, short-term debt, and long-term debt.