Current & Financial Ratios
The current ratio is a financial ratio that measures whether or not a firm has enough resources to pay its debts over the next 12 months. It compares a firm's current assets to its current liabilities. Along with other financial ratios, the current ratio is used to try to evaluate the overall financial condition of a corporation or other organization. Financial ratios may be used by managers within a firm, by current and potential shareholders (owners) of a firm, and by a firm's creditors. Financial analysts use financial ratios to compare the strengths and weaknesses in various companies. Ratios can be expressed as a decimal value, such as 0.10, or given as an equivalent percent value, such as 10% .
Ratios can be used to analyze financial trends.
The current ratio can be use to evaluate a company's liquidity.
The current ratio is calculated by taking total current assets and dividing by total current liabilities.
Uses for Current Ratio
The ratio is an indication of a firm's market liquidity and ability to meet creditor's demands. Acceptable current ratios vary from industry to industry and are generally between 1.5% and 3% for healthy businesses.
If a company's current ratio is in this range, then it generally indicates good short-term financial strength. If current liabilities exceed current assets (the current ratio is below 1), then the company may have problems meeting its short-term obligations (current liabilities).
High vs. Low Current Ratio
If the value of a current ratio is considered high, then the company may not be efficiently using its current assets, specifically cash, or its short-term financing options. A high current ratio can be a sign of problems in managing working capital (what is leftover of current assets after deducting current liabilities). While a low current ratio may indicate a problem in meeting current obligations, it is not indicative of a serious problem. If an organization has good long-term revenue streams, it may be able to borrow against those prospects to meet current obligations. Some types of businesses usually operate with a current ratio of less than one. For example, when inventory turns over more rapidly than accounts payable becomes due, the current ratio will be less than one. This can allow a firm to operate with a low current ratio.