Current Ratio Calculator
Introduction to Current Ratio
The current ratio is a financial metric that measures a company’s ability to cover its short-term liabilities with its current assets. It’s a broader measure of liquidity compared to the cash ratio because it includes not only cash and cash equivalents but also other current assets like accounts receivable and inventory.
With above definition, we can understand that to compute current ratio, we can use the following formula,
Current Ratio = Current Assets / Current Liabilities
Where:
- Current Assets include cash, cash equivalents, accounts receivable, inventory, and other assets expected to be converted into cash within one year.
- Current Liabilities are the obligations that a company is expected to pay within a year, such as short-term debt, accounts payable, and other current liabilities.
Examples to Understand Current Ratio
Now let us look into some examples to understand and interpret the meaning of Current Ratio;
Example 1: Company X
- Current Assets: $200,000
- Current Liabilities: $100,000
Current Ratio = $200,000 / $100,000 = 2.0
In this example, Company X has a current ratio of 2.0, indicating that it has twice as many current assets as current liabilities. This suggests that the company has a strong liquidity position and can comfortably meet its short-term financial obligations.
Example 2: Company Y
- Current Assets: $80,000
- Current Liabilities: $100,000
Current Ratio = $80,000 / $100,000 = 0.8
Company Y has a current ratio of 0.8, meaning it has fewer current assets than current liabilities. This suggests that the company may have difficulties covering its short-term obligations with its current assets alone and might need to consider alternative financing options.
Example 3: Company Z
- Current Assets: $150,000
- Current Liabilities: $150,000
Current Ratio = $150,000 / $150,000 = 1.0
Company Z has a current ratio of 1.0, indicating that it has exactly enough current assets to cover its current liabilities. While this suggests a balanced liquidity position, it doesn’t leave much margin for unexpected changes in financial circumstances.
Like the cash ratio, the acceptable current ratio values can vary between industries and depend on a company’s specific situation and risk tolerance. Companies often aim for a current ratio above 1.0 to ensure they have more current assets than current liabilities.
