What is Current ratio?

Current ratio, also called the working capital ratio, is a liquidity ratio used to measure a business’ ability to meet its short-term liabilities. It compares the firm’s current assets to its current liabilities.

Current ratio formula

Current ratio = Current assets / Current liabilities

Current assets include cash, inventory, accounts receivable, marketable securities, and other current assets that can be liquidated and converted to cash within one year.

Current liabilities include wages, accounts payable, taxes, and the currently due portion of a long-term debt.

A current ratio that is lower than the market average indicates a high risk of default. A current ratio that is way above the market average indicates inefficient use of assets.

Difference between Quick ratio and Current ratio

Both Quick Ratio and Current ratio are indicators of a company’s liquidity. The fundamental difference between both is that quick ratio is a more conservative indicator of liquidity.

The current liabilities taken into account in both cases are the same. But, for the current assets part, quick ratio doesn’t include comparatively less liquid assets like inventory, prepaid expenses, and other current assets that are less liquid.

Fallbacks of Current ratio

Retail stores nearing the holiday season see a sudden spike in their current ratio because of an increase in inventory due to holiday stocking.

If a company’s Current ratio is matching up to the market average but most of their current assets are in the form of inventory which is hard to liquidate in the short-term, then the company isn’t really in a solvent or liquid position.

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