Current Ratio — Investment Wiki

The Current Ratio is a liquidity metric that measures a company's ability to pay short-term obligations or those due within one year. It compares all of a company's current assets to its current liabilities, providing a quick snapshot of financial health and short-term solvency.

Quick Reference

Type	Liquidity Ratio
Formula	Current Assets ÷ Current Liabilities
Good Target	1.5 to 2.0
Best Used For	Assessing short-term bankruptcy risk

1.0 The Formula

Basic Form

formulaCurrent Ratio = Current Assets / Current Liabilities

Both figures are found on the Balance Sheet. Current Assets include cash, cash equivalents, accounts receivable, and inventory (assets expected to be liquidated within a year). Current Liabilities include accounts payable, short-term debt, and accrued liabilities.

Worked Example

Company	Current Assets	Current Liabilities	Current Ratio
Company A	$200M	$100M	2.0x
Company B	$50M	$100M	0.5x

Company A has $2 in assets for every $1 of short-term debt and is extremely safe. Company B cannot cover its short-term debts and risks missing payments if cash flow tightens.

2.0 Interpretation & Edge Cases

Benchmarks

A ratio exactly at 1.0 means assets perfectly match liabilities. A ratio below 1.0 indicates a company may run into liquidity trouble. Ratios over 3.0, while safe, might indicate management is hoarding cash inefficiently rather than investing in growth.

Inventory makes up a large portion of Current Assets. For retailers, if inventory consists of outdated goods that cannot be sold at full price, this ratio artificially overstates liquidity. The Quick Ratio is often a safer alternative.

3.0 Related Pages

Quick Ratio

A stricter liquidity ratio that strips out inventory from current assets.

Debt-to-Equity Ratio

Pairs with the Current Ratio to assess total long-term leverage alongside short-term liquidity.