Current Ratio

Current assets divided by current liabilities; a liquidity measure.

The current ratio is a liquidity metric that measures a company's ability to cover its short-term obligations with its short-term assets. It compares what a business owns that can be turned into cash within one year to what it owes that must be paid within that same timeframe. This ratio helps investors assess whether a company has enough financial runway to meet its immediate bills without needing to raise external capital or sell off long-term assets. To calculate the current ratio, you divide a company's total current assets by its total current liabilities. Both of these figures are easily found on the company's balance sheet. Current assets typically include cash, cash equivalents, accounts receivable, and inventory, while current liabilities include accounts payable, short-term debt, and other accrued liabilities. Investors generally look for a current ratio above 1.0, which indicates that the company has more short-term assets than short-term liabilities. A ratio below 1.0 can be a warning sign of potential liquidity issues or insolvency. However, an excessively high current ratio (such as 3.0 or higher) is not always positive; it may suggest that the company is hoarding cash inefficiently, holding too much slow-moving inventory, or failing to reinvest its capital productively.

Company A has $500,000 in current assets (including $200,000 in cash, $150,000 in inventory, and $150,000 in accounts receivable) and $250,000 in current liabilities (including accounts payable and short-term debt). Its current ratio is calculated as $500,000 / $250,000 = 2.0. This means Company A has $2.00 of short-term assets for every $1.00 of short-term debt.