What is the Current Ratio?

by Craig Anthony

1 min read

As a business owner, it’s important to know if your business can pay its short-term and long-term obligations. To measure this, use the ratio that is most commonly used in the business, the current ratio. The current ratio shows a business’s ability to meet its current liabilities with its current assets. The reason this is so important is because a business can convert its current assets into cash within a year or less and current liabilities are what a business owes within a year or less. The higher the ratio, the strong the position a company is in.The formula for the current ratio is: Current ratio = current assets / liabilitiesTo illustrate, if a company has $500,000 in current assets and $250,000 in current liabilities, the equation expressing its current ratio is: $500,000 / $250,000 = 2The current ratio is an important measure for any business, since it indicates a company’s financial health. A very low current ratio signals that the company may be experiencing financial troubles. A current ratio of less than 1 shows that liabilities due within the next 12 months are higher than the company’s current assets. This can be a major warning sign for investors, banks, or other financial institutions.While a low current ratio shows that a company’s financial health is bad, it doesn’t necessarily mean that the company can’t recover. Likewise, a current ratio higher than 3 often indicates that the company is not utilizing its current assets to the best of its ability.

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