Current ratio: What it is and how to calculate it
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The current ratio indicates a company’s ability to meet its short-term obligations. Those obligations are typically paid for using current assets. The ratio’s calculated by dividing current assets by current liabilities.
An asset is considered current if it can be converted into cash within a year or less. And current liabilities are obligations expected to be paid within one year.
Investors can use this type of liquidity ratio to make comparisons with a company’s peers and competitors. Ultimately, the current ratio helps investors understand a company’s ability to cover its short-term debt with its current assets.
How to calculate the current ratio
You can calculate the current ratio by dividing a company’s total current assets by its total current liabilities. Again, current assets are resources that can quickly be converted into cash within a year or less. This includes cash, accounts receivable and inventories.
Current liabilities include accounts payable, wages, accrued expenses, accrued interest and short-term debt.
The formula is:
Current ratio: Current assets / Current liabilities
Example current ratios
Let’s look at some examples of companies with high and low current ratios. You can find these numbers on a company’s balance sheet under total current assets and total current liabilities. Some stock market sites will also give you the ratio in a list with other common financials, such as valuation, profitability and capitalization. You’ll find the current ratio with other liquidity ratios.
- General Electric’s (GE) current assets in December 2021 were $65.5 billion; its current liabilities were $51.95 billion, making its current ratio 1.26.
- Target (TGT)’s 2022 current ratio was 0.99: its current assets were $21.57 billion and its current liabilities were $21.75 billion.
- Samsung Electronics (SSNLF) in 2021 had ₩221.16 trillion in current assets and ₩88.12 trillion in current liabilities, resulting in an extremely high 2.51 current ratio.
What is a good current ratio?
The ideal current ratio varies by industry. However, an acceptable range for the current ratio could be 1.2 to 2. Ratios in this range indicate that the company has enough current assets to cover its debts, with some wiggle room. A current ratio lower than the industry average could mean the company is at risk for default, and in general, is a riskier investment.
However, special circumstances can affect the current ratio. For example, a financially healthy company could have a one-time, expensive project that requires outlays of cash, say for emergency building improvements. Because buildings aren’t considered current assets, and the project ate through cash reserves, the current ratio could fall below 1.00 until more cash is made.
What is a bad current ratio?
In general, a current ratio below 1.00 suggests that a company’s debts due in a year or less are greater than its assets. This could indicate that the company may struggle to meet its short-term obligations.
However, similar to the example we used above, there can be special circumstances that can negatively affect the current ratio in a healthy company. For instance, take Company EG, which has a large receivable that is unlikely to be collected, or excess inventory that may be obsolete. Both circumstances could reduce the current ratio at least temporarily.
Current ratio vs. quick ratio vs. debt-to-equity
Other measures of liquidity and solvency that are similar to the current ratio might be more useful, depending on the situation. For instance, while the current ratio takes into account all of a company’s current assets and liabilities, it doesn’t account for customer and supplier credit terms, or operating cash flows.
A more conservative measure of liquidity is the quick ratio — also known as the acid-test ratio — which compares cash and cash equivalents only, to current liabilities. The current ratio includes all of a company’s current assets, including those that may not be as easily converted into cash, such as inventory, which can be a misleading representation of liquidity.
To measure solvency, which is the ability of a business to repay long-term debt and obligations, consider the debt-to-equity ratio. This ratio compares a company’s total liabilities to its total equity. It measures how much creditors have provided in financing a company compared to owners and is used by investors as a measure of stability. A highly leveraged company is generally a riskier investment.
Why the current ratio matters
You’ll want to consider the current ratio if you’re investing in a company. When a company’s current ratio is relatively low, it’s a sign that the company may not be able to pay off its short-term debt when it comes due, which could hurt its credit ratings or even lead to bankruptcy. That said, the current ratio should be placed in the context of the company’s historical performance and that of its peers. A current ratio that appears to be good or bad can be better understood by looking at how it changes over time.
For example, a company’s current ratio may appear to be good, when in fact it has fallen over time, indicating a deteriorating financial condition. Companies with an improving current ratio may be undervalued and in the midst of a turnaround, making them potentially attractive investments.
The current ratio is just one indicator of financial health. Like most performance measures, it should be taken along with other factors for well-rounded decision-making.
Correction, Feb. 10, 2023, 2:00 pm ET: A previous version of this article incorrectly listed Samsung’s current assets and current liabilities for 2021 in U.S. dollars. The article has been updated to note that the values are in South Korean Won (KRW).