Current Ratio

The Current Ratio provides a calculable means to determining a company's liquidity in the short term. The terms of the equation Current Assets and Current Liabilities references the assets that can be realized or the liabilities that are payable in less than a year.

Although the Current Ratio formula is fairly simplistic, a company's short term liquidity is important to maintaining a financially sound company. A company that can not maintain their short term debt will quickly become inoperable even if they expect to receive payment on their sales in the future.

Current Ratio Use

One should not paint with a broad brush when comparing Current Ratios of all companies. This is especially true when comparing the Current Ratio of one company to that of another company in an entirely different industry. Different industries, and even possibly different companies within an industry, may have different revenue and liability structures that can affect the recommended Current Ratio.

Evaluating the Current Ratio with that of the same company or a comparable company over many years is generally the advised method. In addition, it may be beneficial to compare the Current Ratio with other finance ratios including inventory ratios, receivable ratios, and the amount of quick assets, or readily available assets. A company that receives payment for the sale of their products more quickly, can remain solvent with a lower Current Ratio compared to a company who receives payments later.