The current ratio is a liquidity ratio that measures a company’s ability to pay short-term obligations or those due within one year. It tells investors and analysts how a company can maximize the current assets on its balance sheet to satisfy its current debt and other payables.
A current ratio that is in line with the industry average or slightly higher is generally considered acceptable. A current ratio that is lower than the industry average may indicate a higher risk of distress or default. Similarly, if a company has a very high current ratio compared with its peer group, it indicates that management may not be using its assets efficiently.
The current ratio is called current because, unlike some other liquidity ratios, it incorporates all current assets and current liabilities. The current ratio is sometimes called the working capital ratio.
Equation: Current Ratio = Current Liabilities / Current Assets
Note: In general and cross industries, Current ration average above 1.0 is usually good
A ratio under 1.00 indicates that the company’s debts due in a year or less are greater than its assets—cash or other short-term assets expected to be converted to cash within a year or less. A current ratio of less than 1.00 may seem alarming, although different situations can negatively affect the ratio in a solid company.
In theory, the higher the current ratio, the more capable a company is of paying its obligations because it has a larger proportion of short-term asset value relative to the value of its short-term liabilities. However, though a high ratio—say, more than 3.00—could indicate that the company can cover its current liabilities three times, it also may indicate that it is not using its current assets efficiently, securing financing very well, or properly managing its working capital.
The current ratio can be a useful measure of a company’s short-term solvency when it is placed in the context of what has been historically normal for the company and its peer group. It also offers more insight when calculated repeatedly over several periods.
Configuration: For this ration to work in a correct way, you must have a GL account group for Current Assets and its code must be “1” and a GL account group for Current Liabilities (Short Term Liabilities) and its code must be “4”
Source: Investopedia
