This ratio is simply a calculation used when examining short-term liquidity. In other words, can you pay off your liabilities with your assets? Just as we wrote in last week's article, this is just a ratio, just a number and doesn't take into account the complete picture. However, it can be used as a tool in determining the financial health of a company.
The Formula for this ratio is:
Current Ratio = Current Assets / Current Liabilities
What to Know: Generally speaking, this number should be above 1, 2 would make a company appear very financial healthy, and below 1 would signify that the company has some potential issues. Of course, as is the case with other ratios, it doesn't tell the whole story. For instance, retail sometimes has a number below one given that a supplier may offer a longer credit period, while the retail shop offers a shorter credit period. Regardless, keeping this number above 1 and closer to 2, is where you want to be located.
What to Remember:
- This ratio:
- Includes all current assets and liabilities.
- It is an indicator of a company's ability to pay back its liabilities with its assets.
- This number should generally be above 1.
- A liability is generally considered current if it is due within a year.
- This is merely a rough estimate of a company's financial health.