The current ratio is a company's current assets divided by its current liabilities. Current assets are what the company expects to turn into cash within a year (cash, money owed by customers, inventory). Current liabilities are the bills and debts that fall due within the same year. A ratio above 1 means the short-term assets are larger than the short-term bills. A related measure, the quick ratio, leaves inventory out and counts only cash and money owed by customers, because inventory can take a long time to sell.
Worked example
Company A has $100,000 in cash, $200,000 owed by customers and $200,000 of inventory, so current assets are $500,000. It owes suppliers and lenders $400,000 within the year. Current ratio = $500,000 ÷ $400,000 = 1.25. Without the inventory, the quick ratio = ($100,000 + $200,000) ÷ $400,000 = 0.75. Both numbers are worth reading together: the company can cover its bills on paper, but only if it manages to sell its stock.
Why it matters
The current ratio is a quick way to ask whether a company could run into trouble paying its short-term bills, which is a core part of financial strength. The figures come from the balance sheet in the annual report. The catch is that there is no single right level: a supermarket often sits below 1 on purpose because it sells goods and collects cash well before it pays its suppliers, while a manufacturer holding lots of slow stock needs a higher figure to be comparable. Inventory quality and seasonal swings also move the number. A low or high reading is a question to look into, not a verdict, so compare it with companies in the same industry and with the company's own past years.
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Frequently asked questions
There is no single good level, because it depends on the industry. A figure above 1 means current assets exceed current liabilities, but a supermarket can run below 1 by design while a manufacturer with slow-moving stock may need more. Compare it with similar companies and with the same company's earlier years.
The current ratio counts all current assets, including inventory. The quick ratio (also called the acid test) leaves inventory out and counts only cash and money owed by customers, so it is a stricter test of whether bills can be paid without selling any stock.
Both numbers are on the balance sheet in the company's annual report, under current assets and current liabilities. Use the same reporting date for both.
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