The current ratio is a financial ratio that measures a company’s ability to pay off its short-term debt obligations with its current assets. It is a commonly used measure of liquidity, as it provides an indication of a company’s ability to meet its financial obligations in the near future.
The formula for calculating the current ratio is as follows:
Current Ratio = Current Assets / Current Liabilities
Current assets include any assets that are expected to be converted into cash within one year, such as cash, accounts receivable, and inventory. Current liabilities include any obligations that are due within one year, such as accounts payable, accrued expenses, and short-term debt.
A higher current ratio indicates that a company has a greater ability to meet its short-term financial obligations with its current assets. However, a very high current ratio may also suggest that a company is not making effective use of its assets and could benefit from investing some of its excess cash into its business or returning it to shareholders through dividends or share buybacks.
Generally, a current ratio of 1.5 or higher is considered to be a good indication of a company’s liquidity, as it suggests that the company has enough current assets to cover its current liabilities. However, the ideal current ratio will vary depending on the industry and the specific circumstances of the company.