Current Ratio
A liquidity measure of whether a firm can cover its short-term obligations with short-term assets.
Formula
Variables
Example
Assets $150k / liabilities $75k = 2.0
How it works
The current ratio compares a company’s short-term resources to its short-term debts, so it gives a quick snapshot of liquidity. It works by dividing assets that should turn into cash within a year, like cash itself, receivables, and inventory, by liabilities that must be paid within a year. A result above 1 suggests the firm has more short-term assets than short-term obligations, while a result below 1 can signal possible cash pressure.
When to use it
Use this ratio when assessing whether a business is likely to meet upcoming bills without needing extra financing or asset sales. It is common in credit analysis, lending decisions, and comparing the short-term financial strength of companies in the same industry.
Worked example, step by step
Current Assets = $96,000 Current Liabilities = $64,000 CR = Current Assets / Current Liabilities CR = 96,000 / 64,000 CR = 1.5 Final answer: The current ratio is 1.5, meaning the company has $1.50 of current assets for every $1 of current liabilities.
Common mistakes to avoid
- Including long-term assets or long-term debt in the calculation
- Assuming a higher ratio is always better without considering inefficient use of assets
- Comparing businesses in very different industries without accounting for normal liquidity patterns
Did You Know?
A ratio near 1.5–3 is generally healthy; far above may signal idle cash, far below a cash crunch.
Share this formula
More in Accounting
View allAccounting Equation
BasicThe foundation of double-entry bookkeeping: everything a business owns is financed either by debt or by owners’ capital.
Cost of Goods Sold
BasicThe direct cost of the inventory actually sold during a period.
Gross Profit
BasicWhat remains from sales after subtracting the direct cost of the goods sold, before operating expenses.
Net Income
BasicThe “bottom line” — total earnings after all expenses, interest and taxes are deducted from revenue.
Retained Earnings
BasicCumulative profit kept in the business rather than paid out to shareholders.
Quick Ratio (Acid Test)
IntermediateA stricter liquidity test that excludes inventory, which can be slow to convert to cash.