| current ratio A measure of a firm's ability to meet its short-term obligations. The current ratio is calculated by dividing current assets by current liabilities. Both variables are shown on the balance sheet. A relatively high current ratio compared with those of other firms in the same business indicates high liquidity and generally conservative management, although it may tend to result in reduced profitability. See also cash ratio, quick ratio. |
What Does Current Ratio Mean?
Also known as liquidity ratio, cash asset ratio, and cash ratio; a liquidity ratio that measures a company's ability to pay short-term obligations. It is calculated as follows:
Investopedia explains Current Ratio
The current ratio is used primarily to ascertain a company's ability to pay back its short-term liabilities (debt and payables) with its short-term assets (cash, inventory, receivables). The higher the current ratio, the better the company's ability to pay its obligations. A ratio under 1 suggests that the company would be unable to pay off its obligations if they came due at that point. Although this may indicate that the company is not in good financial health, it does not necessarily mean that it will go bankrupt—there are many ways to access financing—but it is definitely not a good sign. The current ratio can give a sense of the efficiency of a company's operating cycle or its ability to turn its product into cash. Companies that have trouble collecting their receivables or have long inventory turnover can run into liquidity problems. Since businesses differ by industry, it is best to use this ratio to compare companies within the same industry. This ratio is similar to the acid-test ratio except that the acidtest ratio does not consider inventory and prepaids as liquid assets. The components of the current ratio (current assets and current liabilities) can be used to derive working capital (difference between current assets and current liabilities). Working capital frequently is used to calculate the working capital ratio, which is working capital as a ratio of sales.
Related Terms:
• Current Assets
• Current Liabilities
• Inventory Turnover
• Liquidity Ratios
• Receivables Turnover Ratio
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