Current Ratio

Reviewed by Vineeth | Updated on Sep 28, 2020

Introduction

The current ratio is the liquidity ratio which measures the company’s capability to standby their short-term liabilities and obligations, specifically the ones that are to be paid within a period of twelve months. It indicates to the investors and analysts that how well the company is capable of optimising the existing assets in its balance sheets to take up the responsibility of its debt and other liabilities.

Formula

To calculate the current ratio, investors and analysts will compare the company’s existing assets with its existing liabilities. Current or existing assets that are listed in the company’s balance sheets include accounts receivable, cash, inventories, and other assets that are anticipated to undergo the process of liquidation or being converted into cash within the period of twelve months.

Current or existing liabilities include taxes due, wages, accounts payable, and the existing portion of the long-term debt. Given below is the formula to calculate the current ratio:

Current ratio = Current Assets / Current Liabilities

The current ratio, which is in sync with the industry standards or somewhat higher, is usually accepted by investors and analysts. The current ratio that is slightly lower than the industry average will imply that there is a possibility of a higher risk of default or distress.

Likewise, if the company has a very high current ratio among its competitors or peers, then it implies that the company’s management is not utilising the company’s assets effectively.

A current ratio of less than one can indicate that there are some underlying problems in the company. Nevertheless, several situations are affecting the current ratio of a well-established company.

Current

The current ratio is generally referred to as ‘current’. Unlike other ratios related to liquidity, it includes every current liability and asset. The current ratio is also referred to as the working capital ratio by analysts.

Related Terms

  • Statutory Audit

    A statutory audit is a legally required check of the accuracy of the financial statements and records of a company or government.   Read more


  • Gross Working Capital

    Gross working capital refers to the total current assets of a company.   Read more


  • Deferred Revenue

    Deferred revenue, also called unearned revenue, applies to advance payments obtained by a company for goods or services that are to be provided or performed in the future.   Read more


  • Operating Revenue

    Operating revenue refers to the revenue generated by a company from its primary activities.   Read more


  • Escalator Clause

    An escalator clause is also known as an escalation clause, where the provision allows for an automatic increase in the wages or prices.   Read more


  • Agency Problem

    The agency problem is a scenario of a conflict of interest which is inherent in all relations wherein one party is anticipated to operate in the best interests of another party.   Read more


Recent Terms

  • Amortisation

    Amortisation is an accounting strategy used to regularly reduce a loan's book value or an intangible asset's book value over a given period of time.   Read more


  • Rationalisation

    The reorganisation of a firm with the view of enhancing the efficiency of the operation is referred to as the rationalisation.   Read more


  • Profit Centre

    A profit centre refers to a branch, unit, or division of a company which directly adds or which normally adds to the bottom-line or profits of the company as a whole.   Read more


  • Authorised Share Capital

    Authorised share capital is the number of stock units (shares) that a company may issue, as set out in its association memorandum or incorporation papers.   Read more