Definition of the Current Ratio

Current ratio is a liquidity measure of a company's ability to pay short-term or one-year obligations. It tells investors and analysts how a company can maximize the current assets on its balance sheet to satisfy its current debt and other liabilities.

Formula of the Current Ratio

$\text{Current Ratio}=\frac{\text{Current Assets}}{\text{Current Liabilities}}$

Interpretation of the Current Ratio

A ratio below 1.00 indicates that the company's liabilities due in one year or less are greater than its assets - cash or other short-term assets expected to be converted to cash within one year or less. A current ratio of less than 1.00 may seem alarming, although various situations can negatively affect the current ratio of a solid company.

In theory, the higher the current ratio, the better a company's ability to pay its obligations because it has a greater proportion of the value of its short-term assets relative to the value of its short-term liabilities. However, while a high ratio - say, over 3.00 - could indicate that the company can cover its current liabilities three times over, it could also indicate that the company is not using its current assets efficiently, is not securing financing very well, or is not managing its working capital properly.