Current ratio

Current assets are cash and the things that should become cash within twelve months: money customers owe, inventory, short-term investments and prepaid expenses. Current liabilities are the bills due within the same twelve months: money owed to suppliers, short-term loans, the part of long-term debt that falls due this year, wages and taxes owed.

The current ratio divides the first by the second. A ratio of 1.5 means the company holds $1.50 of current assets for every $1 it has to pay in the coming year.

Both numbers come from the balance sheet, where companies list current assets and current liabilities as separate subtotals. Working capital is the same comparison as a difference instead of a ratio: a current ratio above 1 means working capital is positive.

A company reports $600 million of current assets: $150 million in cash, $200 million owed by customers and $250 million of inventory. Its current liabilities are $400 million. The current ratio is 600 ÷ 400 = 1.5, and working capital is $200 million.

If it took a $100 million loan due within the year and kept the cash, both sides would grow by $100 million and the ratio would fall to 700 ÷ 500 = 1.4. If it used $100 million of cash to repay suppliers, both sides would shrink and the ratio would rise to 500 ÷ 300, about 1.67, though the company holds less cash than before.

• Below 1 means current liabilities exceed current assets. The company needs cash from operations, new borrowing or asset sales to cover the gap. That is a warning for many businesses, not for all.
• Between about 1.2 and 2 is often described as comfortable for an industrial or consumer company, but there is no universal rule.
• Some healthy businesses run below 1 for years. Retailers and restaurants turn inventory into cash quickly and collect from customers at once, while paying suppliers later, so they can operate with little working capital.
• A very high ratio is not automatically good. It can mean idle cash, slow-moving inventory or customers who pay late.
• The trend matters as much as the level. A ratio that falls year after year deserves a closer look even if it is still above 1.

Inventory can be hard to turn into cash quickly, so two stricter versions leave part of the current assets out.

The quick ratio is also called the acid-test ratio. For the company in the example, it is (150 + 200) ÷ 400, about 0.88, and the cash ratio is 150 ÷ 400, about 0.38. The gap between the current ratio and the quick ratio shows how much of the cushion is inventory.

• It is a snapshot of one day, the balance sheet date. Seasonal businesses can look very different at the end of their busy season than in the middle of it.
• Not every current asset is worth its book value. Inventory may only turn into cash at a deep discount, and some receivables are never collected.
• Companies can tidy the number just before the year ends, for example by repaying short-term debt from cash, as the example shows.
• It says nothing about long-term debt due in two years or about the cash the business generates. A company with steady operating cash flow can safely run a lower ratio than one that burns cash.
• Banks, brokers and insurers do not split their balance sheets into current and non-current parts in the same way, so the ratio does not apply to them.

• Current assets divided by current liabilities from the balance sheet at the end of the latest completed fiscal year, in the company's annual report filed with the SEC.
• If either subtotal is missing, the ratio is shown as unavailable rather than estimated.
• On the company page the current ratio is compared with sector peers next to debt to EBITDA, as part of financial health; a higher value ranks better.
• The Piotroski F-Score uses it too: one of the nine checks asks whether the current ratio improved since the previous year.
• It is not used for banks, brokers, insurers and REITs.