What the current ratio tells you
The current ratio compares two totals from the same balance sheet date. Current assets are cash and the assets a business expects to turn into cash or use up within a year, such as receivables and inventory. Current liabilities are the obligations due within the same year, such as amounts owed to suppliers, short-term loans and the part of long-term debt that falls due within twelve months.
A result of 2.00 means current assets are twice current liabilities. A result below 1.00 means current liabilities are larger than current assets, so the business would need cash from future sales, new borrowing or other sources to meet everything due in the year.
Reading a high or low result
No single figure is right for every business. What is comfortable depends on how quickly the business turns inventory and receivables into cash, and how predictable its cash flow is.
- A low ratio can signal pressure on short-term cash. It is less of a concern for a business that sells its inventory and collects from customers quickly, because its current assets turn into cash sooner.
- A high ratio gives more cover for short-term obligations, but it can also point to slow-moving inventory, receivables that are not being collected, or cash that is sitting idle.
The ratio is most useful when you compare it with the same business in earlier periods, or with similar businesses that report on the same basis.
What the ratio does not show
- It treats every current asset as equally available. Inventory can take months to sell, and some receivables may never be collected. The quick ratio leaves inventory and prepaid expenses out for this reason.
- It is a snapshot of one date. A seasonal business can show very different figures at different points in the year.
- It says nothing about timing within the year: a bill due next week counts the same as one due in eleven months.
Common mistakes
- Taking current assets and current liabilities from different dates. Both should come from the same balance sheet.
- Leaving out the current portion of long-term debt, which belongs in current liabilities.
- Comparing businesses without checking that they classify their assets and liabilities the same way.
Related measures
Working capital uses the same two figures but subtracts instead of dividing, so it gives an amount rather than a ratio. The cash ratio is the strictest test: it counts only cash and cash equivalents. To see the current and quick ratios side by side, use current ratio vs quick ratio.