Current ratio

Definition

The current ratio measures a company's ability to pay short-term obligations with its current assets. It is calculated by dividing current assets by current liabilities.

5 Must Know Facts For Your Next Test

1. A current ratio above 1 indicates that a company has more current assets than current liabilities, suggesting good short-term financial health.
2. A very high current ratio may indicate inefficient use of assets or excessive inventory.
3. The ideal range for a healthy current ratio typically falls between 1.5 and 3, depending on industry norms.
4. A current ratio below 1 suggests that a company might struggle to meet its short-term obligations.
5. Commonly used in financial analysis, the current ratio helps investors and creditors assess liquidity risk.

Review Questions

• How is the current ratio calculated?
• What does a current ratio below 1 indicate about a company's financial health?
• Why might a very high current ratio be considered problematic?

Related terms

Quick Ratio:

Also known as the acid-test ratio, it measures a company's ability to meet short-term obligations using only its most liquid assets.

Current Assets:

Assets that are expected to be converted into cash or used up within one year, including cash, accounts receivable, and inventory.

Current Liabilities:

Obligations that are due to be settled within one year, such as accounts payable and short-term debt.