Current Ratio

Definition - What does Current Ratio mean?

Current ratio identifies the current assets of a business or corporation in relation to its current liabilities, which are expected to be settled within the year. For example, if a company had a current ratio of two, this would indicate that they had current short-term assets (cash, marketable securities, inventory, and accounts receivable) that were two times the amount of their outstanding short-term liabilities (current portion of term debt, taxes, accrued expenses, and notes payable).

Justipedia explains Current Ratio

Analysts use current ratio to evaluate the liquidity of a company and the company’s ability to meet their financial obligations. For example, if a company has an acceptable current ratio, which varies by industry, market analysts assume that the company’s financial strength is fine, and that they should be able to meet their creditor’s demands.

In general, whether a low current ratio is bad and a high current ratio is good will depend on the industry. In some industries, problems in liquidity can arise if the current ratio is below 1, which might indicate that the company may not have enough assets to meet their short-term financial obligations.

In other industries, however, a high current ratio could be better, but it also could be an indication that the company is failing to use its resources effectively and is not making sound use of its working capital.

Bottom line: Current ratio is only one indication of a company's overall health. Before making financial investments or decisions, it is much more important for financial analysts to understand whether a company has the resources to meet its financial obligations based on the current assets held by the company.

For example, certain companies might have a great deal of working capital, leading to a high current ratio, but if their assets were not liquid enough to convert to cash (or they did not have enough cash on hand), they would be unable to pay their bills.

Share this:

Connect with us

Find a Lawyer