What is the current ratio?
Short answer
The current ratio is current assets divided by current liabilities. It shows how many dollars of assets due within a year are available for each dollar of obligations due within a year. A value below 1 means current liabilities exceed current assets. A good value depends on the industry and business model.
The current ratio is a liquidity ratio. It compares the assets a company expects to turn into cash within a year with the obligations it must settle within the same year. The formula is:
Current ratio = current assets / current liabilities
Current assets are cash, receivables, inventory and other items due or expected to convert to cash within twelve months. Current liabilities are obligations due within twelve months, such as accounts payable, accrued expenses and the current portion of debt. Both figures come from the balance sheet at the same date. The financial ratio analysis guide sets the ratio alongside the others.
How do I calculate a current ratio from a balance sheet?
Take the year 1 balance sheet of a fictional company, in USD thousands. Current assets are 895 and current liabilities are 375. The current ratio is:
895 / 375 = 2.39
The company holds $2.39 of current assets for each $1 of current liabilities. That is a comfortable margin on paper, but the ratio counts inventory of 360 as liquid, and inventory must be sold before it becomes cash.
How does the quick ratio differ from the current ratio?
The quick ratio removes inventory from the numerator, because inventory is the least liquid current asset:
Quick ratio = (current assets - inventory) / current liabilities
For the same company, (895 - 360) / 375 = 1.43. The quick ratio is lower because 40% of current assets is inventory. A large gap between the two ratios means that the company's liquidity depends on selling its stock. Some analysts also exclude prepaid expenses from the quick ratio. Whichever definition is used, state it when comparing results.
What does a current ratio value tell me?
A value below 1 means current liabilities are greater than current assets. The company would then need cash from operations or new financing to meet obligations due within the year. A value below 1 is not always a problem. Some businesses collect cash from customers before they pay their suppliers, and they can run below 1 for long periods without strain.
A good value depends on the industry and the business model. There is no universal target that applies to every company. Compare the ratio with the company's own trend over several years, and with companies that have similar cash cycles.
How do I calculate the current ratio in a spreadsheet?
Enter current assets in B2, current liabilities in B3 and inventory in B4. Then:
- Current ratio, B6:
=B2/B3 - Quick ratio, B7:
=(B2-B4)/B3
Format both cells with two decimal places. If the ratio needs a history, place each year in its own column and copy the formulas across. The financial ratio analysis template calculates these ratios with the other core measures from a balance sheet and income statement.
For the bank balance that feeds the cash line of current assets, see what is a bank reconciliation.