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Current Ratio: Meaning, Formula & Examples

Nupur Wankhede

Understand what the current ratio means, how it is calculated, and how it helps measure a company’s short-term liquidity and financial health.

The current ratio is a key liquidity metric that evaluates a company’s ability to meet its short-term liabilities with its short-term assets.

It indicates whether a business has enough resources to cover obligations due within a year, offering insight into its operational stability and liquidity management.

A higher ratio suggests strong liquidity, while a very high or very low ratio may reflect inefficiency or financial stress.

What Is the Current Ratio

The current ratio measures how efficiently a company can pay its short-term debts using assets that can be easily converted into cash.

It is one of the most widely used liquidity ratios by analysts, creditors, and investors to assess a firm’s financial resilience.

A current ratio of 1 means the company has equal current assets and liabilities, whereas a ratio above 1 indicates a comfortable liquidity position.

Current Ratio Formula

The formula to calculate the current ratio is:

  • Current Ratio = Current Assets ÷ Current Liabilities

Component Explanation

Current Assets

Assets expected to be converted into cash within a year (cash, receivables, inventory).

Current Liabilities

Obligations due within a year (trade payables, short-term loans, accrued expenses).

How to Calculate Current Ratio

Let’s understand with an example:

  • Current Assets: ₹5,00,000

  • Current Liabilities: ₹2,50,000

Current Ratio = ₹5,00,000 ÷ ₹2,50,000 = 2.0

This means the company has ₹2 in current assets for every ₹1 of current liabilities, implying a strong liquidity position.

Pros of Current Ratio

The current ratio offers several analytical advantages:

  • Quick Liquidity Insight: Provides an instant view of the company’s ability to meet short-term obligations.

  • Comparative Benchmarking: Useful for comparing liquidity across firms or tracking changes over time.

  • Lender Confidence: A stable ratio improves creditworthiness and access to financing.

  • Operational Assessment: Indicates whether working capital is being managed efficiently.

Cons of Current Ratio

Despite its usefulness, the ratio has limitations:

  • Doesn’t Reflect Cash Flow Timing: Assets like inventory may not convert quickly into cash.

  • Can Be Distorted: A high ratio may indicate idle assets rather than liquidity strength.

  • Industry Variation: What’s considered healthy varies widely across sectors.

  • Ignores Asset Quality: It assumes all current assets are equally liquid and collectible.

Thus, it should be analysed alongside quick and cash ratios for a fuller picture.

Current Ratio vs Other Liquidity Ratios

The current ratio offers a broader liquidity view, while other ratios provide stricter assessments of solvency.

Ratio Formula Focus

Current Ratio

Current Assets ÷ Current Liabilities

Measures total liquidity.

Quick Ratio

(Current Assets - Inventory) ÷ Current Liabilities

Focuses on most liquid assets.

Cash Ratio

Cash & Equivalents ÷ Current Liabilities

Shows cash-only coverage ability.

Use Cases & Importance for Stakeholders

The current ratio is vital across stakeholder groups:

  • Investors: Assess short-term solvency before investing.

  • Creditors: Evaluate repayment capability before extending credit.

  • Management: Monitor working capital efficiency and liquidity trends.

  • Regulators: Identify potential liquidity risks in financial institutions.

Generally, a ratio between 1.5 and 2.0 is considered healthy, though industry benchmarks vary.

Conclusion & Key Takeaways

The current ratio remains a fundamental indicator of short-term financial strength.

It helps determine whether a business can sustain daily operations and meet immediate obligations.

Key takeaway:

  • A ratio around 2 often reflects good liquidity.

  • Below 1 signals potential liquidity stress.

  • Above 3 might indicate underutilised assets.

Regular monitoring ensures balanced financial management and business stability.

Disclaimer

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.

FAQs

What does the current ratio measure?

The current ratio measures a company’s ability to meet its short-term obligations using its short-term assets, providing a clear view of liquidity and overall financial stability.

How does the current ratio differ across industries?

The current ratio varies by industry; capital-intensive businesses generally operate with lower ratios, while service-oriented firms maintain higher liquidity due to fewer inventory requirements.

What is an example of the current ratio?

For example, if a company has ₹3,00,000 in current assets and ₹1,50,000 in current liabilities, its current ratio is 2, meaning it has twice as many assets as liabilities, showing strong liquidity.

What is the formula of current ratio?

The current ratio is calculated using the formula Current Assets ÷ Current Liabilities, which determines how efficiently a company can pay off its short-term debts with its available resources.

Hi! I’m Nupur Wankhede
BSE Insitute Alumni

With a Postgraduate degree in Global Financial Markets from the Bombay Stock Exchange Institute, Nupur has over 8 years of experience in the financial markets, specializing in investments, stock market operations, and project management. She has contributed to process improvements, cross-functional initiatives & content development across investment products. She bridges investment strategy with execution, blending content insight, operational efficiency, and collaborative execution to deliver impactful outcomes.

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