{"id":1039,"date":"2023-09-03T16:39:27","date_gmt":"2023-09-03T21:39:27","guid":{"rendered":"https:\/\/finallylearn.com\/?p=1039"},"modified":"2023-09-14T15:43:50","modified_gmt":"2023-09-14T20:43:50","slug":"current-ratio","status":"publish","type":"post","link":"https:\/\/finallylearn.com\/current-ratio\/","title":{"rendered":"Current Ratio Formula and Examples"},"content":{"rendered":"\n<p><strong>The current ratio estimates an entity&#8217;s ability to pay its short-term debts. The current ratio formula is current assets divided by current liabilities.<\/strong><\/p>\n\n\n\n<p><strong>A current ratio of 1.5 to 2.0 is good, and a current ratio less than 1.0 is poor. <\/strong><\/p>\n\n\n\n<!--more-->\n\n\n\n<div id=\"ez-toc-container\" class=\"ez-toc-v2_0_82_2 counter-hierarchy ez-toc-counter ez-toc-light-blue ez-toc-container-direction\">\n<p class=\"ez-toc-title\" style=\"cursor:inherit\">Contents<\/p>\n<label for=\"ez-toc-cssicon-toggle-item-69f08e36c0b17\" class=\"ez-toc-cssicon-toggle-label\"><span class=\"ez-toc-cssicon\"><span class=\"eztoc-hide\" style=\"display:none;\">Toggle<\/span><span class=\"ez-toc-icon-toggle-span\"><svg style=\"fill: #999;color:#999\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" class=\"list-377408\" width=\"20px\" height=\"20px\" viewBox=\"0 0 24 24\" fill=\"none\"><path d=\"M6 6H4v2h2V6zm14 0H8v2h12V6zM4 11h2v2H4v-2zm16 0H8v2h12v-2zM4 16h2v2H4v-2zm16 0H8v2h12v-2z\" fill=\"currentColor\"><\/path><\/svg><svg style=\"fill: #999;color:#999\" class=\"arrow-unsorted-368013\" xmlns=\"http:\/\/www.w3.org\/2000\/svg\" width=\"10px\" height=\"10px\" viewBox=\"0 0 24 24\" version=\"1.2\" baseProfile=\"tiny\"><path d=\"M18.2 9.3l-6.2-6.3-6.2 6.3c-.2.2-.3.4-.3.7s.1.5.3.7c.2.2.4.3.7.3h11c.3 0 .5-.1.7-.3.2-.2.3-.5.3-.7s-.1-.5-.3-.7zM5.8 14.7l6.2 6.3 6.2-6.3c.2-.2.3-.5.3-.7s-.1-.5-.3-.7c-.2-.2-.4-.3-.7-.3h-11c-.3 0-.5.1-.7.3-.2.2-.3.5-.3.7s.1.5.3.7z\"\/><\/svg><\/span><\/span><\/label><input type=\"checkbox\"  id=\"ez-toc-cssicon-toggle-item-69f08e36c0b17\" checked aria-label=\"Toggle\" \/><nav><ul class='ez-toc-list ez-toc-list-level-1 ' ><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-1\" href=\"https:\/\/finallylearn.com\/current-ratio\/#What-is-the-current-ratio\" >What is the current ratio?&nbsp;<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-2\" href=\"https:\/\/finallylearn.com\/current-ratio\/#What-is-the-current-ratio-formula\" >What is the current ratio formula?&nbsp;<\/a><ul class='ez-toc-list-level-3' ><li class='ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-3\" href=\"https:\/\/finallylearn.com\/current-ratio\/#Current-Assets\" >Current Assets<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-3'><a class=\"ez-toc-link ez-toc-heading-4\" href=\"https:\/\/finallylearn.com\/current-ratio\/#Current-Liabilities\" >Current Liabilities<\/a><\/li><\/ul><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-5\" href=\"https:\/\/finallylearn.com\/current-ratio\/#How-to-calculate-the-current-ratio\" >How to calculate the current ratio<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-6\" href=\"https:\/\/finallylearn.com\/current-ratio\/#Walmart-2022-current-ratio\" >Walmart 2022 current ratio<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-7\" href=\"https:\/\/finallylearn.com\/current-ratio\/#How-is-the-current-ratio-expressed\" >How is the current ratio expressed?&nbsp;<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-8\" href=\"https:\/\/finallylearn.com\/current-ratio\/#Current-ratio-key-facts\" >Current ratio key facts<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-9\" href=\"https:\/\/finallylearn.com\/current-ratio\/#Liquidity-ratios\" >Liquidity ratios<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-10\" href=\"https:\/\/finallylearn.com\/current-ratio\/#Alternate-names\" >Alternate names<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-11\" href=\"https:\/\/finallylearn.com\/current-ratio\/#Alternate-formula\" >Alternate formula&nbsp;<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-12\" href=\"https:\/\/finallylearn.com\/current-ratio\/#Current-ratio-interpretation\" >Current ratio interpretation<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-13\" href=\"https:\/\/finallylearn.com\/current-ratio\/#What-is-a-good-current-ratio\" >What is a good current ratio?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-14\" href=\"https:\/\/finallylearn.com\/current-ratio\/#What-if-current-ratio-is-too-low\" >What if current ratio is too low?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-15\" href=\"https:\/\/finallylearn.com\/current-ratio\/#What-if-current-ratio-is-too-high\" >What if current ratio is too high?<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-16\" href=\"https:\/\/finallylearn.com\/current-ratio\/#Limitation-false-liquidity\" >Limitation: false liquidity&nbsp;<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-17\" href=\"https:\/\/finallylearn.com\/current-ratio\/#Opportunity-cost-and-liquidity-ratios\" >Opportunity cost&nbsp;and liquidity ratios&nbsp;<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-18\" href=\"https:\/\/finallylearn.com\/current-ratio\/#Opportunity-costs-and-low-returns\" >Opportunity costs and low returns<\/a><\/li><li class='ez-toc-page-1 ez-toc-heading-level-2'><a class=\"ez-toc-link ez-toc-heading-19\" href=\"https:\/\/finallylearn.com\/current-ratio\/#Opportunity-cost-example\" >Opportunity cost example<\/a><\/li><\/ul><\/nav><\/div>\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"What-is-the-current-ratio\"><\/span>What is the current ratio?&nbsp;<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>The current ratio measures the firm\u2019s ability to pay its short-term debts.&nbsp;Current&nbsp;assets and&nbsp;current&nbsp;liabilities have a maturity of less than one year. So, the current ratio shows the firm\u2019s ability to pay its debts over the next year.<\/p>\n\n\n\n<p class=\"has-text-align-left\">It measures the ratio of&nbsp;current&nbsp;assets to&nbsp;current&nbsp;liabilities. Higher values show greater liquidity and a stronger financial position. Lower values show less liquidity.<\/p>\n\n\n\n<p>Creditors are interested in the current ratio and other <a href=\"https:\/\/finallylearn.com\/liquidity-ratios\/\">liquidity ratios<\/a> since higher values show a greater probability of repayment.&nbsp;<\/p>\n\n\n\n<p>The current ratio needs to be high enough to provide financial stability and basic liquidity for the firm.&nbsp;1.00 is generally considered the&nbsp;minimum acceptable value.<\/p>\n\n\n\n<p>With a current ratio of 1.00, the firm could theoretically pay&nbsp;all&nbsp;its current liabilities using only its current assets.&nbsp;Higher values indicate more liquidity and a greater ability to survive bad times.&nbsp;<\/p>\n\n\n\n<figure class=\"wp-block-image aligncenter size-large\"><img loading=\"lazy\" decoding=\"async\" width=\"1024\" height=\"344\" src=\"https:\/\/finallylearn.com\/wp-content\/uploads\/2021\/11\/current-ratio-definition-1024x344.webp\" alt=\"\" class=\"wp-image-3417\" srcset=\"https:\/\/finallylearn.com\/wp-content\/uploads\/2021\/11\/current-ratio-definition-1024x344.webp 1024w, https:\/\/finallylearn.com\/wp-content\/uploads\/2021\/11\/current-ratio-definition-300x101.webp 300w, https:\/\/finallylearn.com\/wp-content\/uploads\/2021\/11\/current-ratio-definition-768x258.webp 768w, https:\/\/finallylearn.com\/wp-content\/uploads\/2021\/11\/current-ratio-definition.webp 1200w\" sizes=\"auto, (max-width: 1024px) 100vw, 1024px\" \/><\/figure>\n\n\n\n<p><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"What-is-the-current-ratio-formula\"><\/span>What is the current ratio formula?&nbsp;<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>The&nbsp;current ratio formula is <strong>current assets \/ current liabilities<\/strong>.&nbsp;Current assets and current liabilities are both shown on the <a href=\"https:\/\/finallylearn.com\/balance-sheet\/\" data-type=\"post\" data-id=\"2326\">balance sheet.<\/a><\/p>\n\n\n\n<p><\/p>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Current-Assets\"><\/span>Current Assets<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>Current assets are short-term assets expected to be used or converted to cash within one year. Examples of current assets include:<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>cash<\/li>\n\n\n\n<li>receivables<\/li>\n\n\n\n<li>inventory<\/li>\n\n\n\n<li>marketable securities<\/li>\n\n\n\n<li>prepaid expenses<\/li>\n<\/ul>\n\n\n\n<h3 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Current-Liabilities\"><\/span>Current Liabilities<span class=\"ez-toc-section-end\"><\/span><\/h3>\n\n\n\n<p>Current liabilities are short-term debts due within one year. These current liabilities include: <\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>accounts payable<\/li>\n\n\n\n<li>wages payable<\/li>\n\n\n\n<li>income tax payable<\/li>\n\n\n\n<li>notes payable (short-term)<\/li>\n\n\n\n<li>other short-term debts<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"How-to-calculate-the-current-ratio\"><\/span>How to calculate the current ratio<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<figure class=\"wp-block-image aligncenter size-full\"><img loading=\"lazy\" decoding=\"async\" width=\"2308\" height=\"622\" src=\"https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-formula.jpg\" alt=\"Current Ratio Formula\" class=\"wp-image-5210\" srcset=\"https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-formula.jpg 2308w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-formula-300x81.jpg 300w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-formula-1024x276.jpg 1024w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-formula-768x207.jpg 768w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-formula-1536x414.jpg 1536w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-formula-2048x552.jpg 2048w\" sizes=\"auto, (max-width: 2308px) 100vw, 2308px\" \/><figcaption class=\"wp-element-caption\">Current Ratio Formula<\/figcaption><\/figure>\n\n\n\n<p>For example, assume current assets are $150,000 and current liabilities are $100,000. The current ratio shows 1.50. So, for every dollar in current liabilities, the company has $1.50 in current assets.<\/p>\n\n\n\n<figure class=\"wp-block-image aligncenter size-full\"><img loading=\"lazy\" decoding=\"async\" width=\"2308\" height=\"622\" src=\"https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-example.jpg\" alt=\"\" class=\"wp-image-5211\" srcset=\"https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-example.jpg 2308w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-example-300x81.jpg 300w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-example-1024x276.jpg 1024w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-example-768x207.jpg 768w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-example-1536x414.jpg 1536w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/current-ratio-example-2048x552.jpg 2048w\" sizes=\"auto, (max-width: 2308px) 100vw, 2308px\" \/><figcaption class=\"wp-element-caption\">Current Ratio Example<\/figcaption><\/figure>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Walmart-2022-current-ratio\"><\/span>Walmart 2022 current ratio<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>To compute the&nbsp;current&nbsp;ratio,&nbsp;we need information from the&nbsp;balance&nbsp;sheet.&nbsp;Here is information from the <a href=\"https:\/\/s201.q4cdn.com\/262069030\/files\/doc_financials\/2022\/ar\/WMT-FY2022-Annual-Report.pdf\" target=\"_blank\" rel=\"noreferrer noopener\">Walmart Inc. 2022 Balance Sheet<\/a>:<\/p>\n\n\n\n<figure class=\"wp-block-table aligncenter is-style-stripes\"><table><thead><tr><th class=\"has-text-align-left\" data-align=\"left\">Walmart Inc.<\/th><th class=\"has-text-align-right\" data-align=\"right\">2022<\/th><\/tr><\/thead><tbody><tr><td class=\"has-text-align-left\" data-align=\"left\"><strong>Current Assets<\/strong>&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">\u202f&nbsp;<\/td><\/tr><tr><td class=\"has-text-align-left\" data-align=\"left\">Cash&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">&nbsp;$14.760&nbsp;<\/td><\/tr><tr><td class=\"has-text-align-left\" data-align=\"left\">Receivables&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">&nbsp;      8,280&nbsp;<\/td><\/tr><tr><td class=\"has-text-align-left\" data-align=\"left\">Inventory&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">&nbsp;      56,511<\/td><\/tr><tr><td class=\"has-text-align-left\" data-align=\"left\">Other current assets<\/td><td class=\"has-text-align-right\" data-align=\"right\">&nbsp;      1,519<\/td><\/tr><tr><td class=\"has-text-align-left\" data-align=\"left\"><strong>Current Assets&nbsp;<\/strong><\/td><td class=\"has-text-align-right\" data-align=\"right\"><strong>$81,070<\/strong><\/td><\/tr><tr><td class=\"has-text-align-left\" data-align=\"left\">\u202f&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">\u202f&nbsp;<\/td><\/tr><tr><td class=\"has-text-align-left\" data-align=\"left\"><strong>Current Liabilities&nbsp;<\/strong><\/td><td class=\"has-text-align-right\" data-align=\"right\"><strong>&nbsp;$87,379<\/strong><\/td><\/tr><\/tbody><\/table><figcaption class=\"wp-element-caption\">Walmart 2022 Current Assets and Current Liabilities<\/figcaption><\/figure>\n\n\n\n<p>The current ratio for Walmart Inc. in 2022 is:&nbsp;<\/p>\n\n\n\n<figure class=\"wp-block-image aligncenter size-full\"><img loading=\"lazy\" decoding=\"async\" width=\"2308\" height=\"622\" src=\"https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/walmart-2022-current-ratio.jpg\" alt=\"Walmart 2022 Current Ratio\" class=\"wp-image-5208\" srcset=\"https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/walmart-2022-current-ratio.jpg 2308w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/walmart-2022-current-ratio-300x81.jpg 300w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/walmart-2022-current-ratio-1024x276.jpg 1024w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/walmart-2022-current-ratio-768x207.jpg 768w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/walmart-2022-current-ratio-1536x414.jpg 1536w, https:\/\/finallylearn.com\/wp-content\/uploads\/2022\/09\/walmart-2022-current-ratio-2048x552.jpg 2048w\" sizes=\"auto, (max-width: 2308px) 100vw, 2308px\" \/><figcaption class=\"wp-element-caption\">Walmart 2022 Current Ratio<\/figcaption><\/figure>\n\n\n\n<p>The current ratio in this example is 0.93. So, for every $1.00 of current liabilities, there are $0.93 of current assets.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"How-is-the-current-ratio-expressed\"><\/span>How is the current ratio expressed?&nbsp;<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>The current&nbsp;ratio&nbsp;is expressed as a multiple. So, based on the problem above, the current ratio is 1.50.<\/p>\n\n\n\n<p><strong>The current ratio should not be expressed as a percent.<\/strong> The answer of 1.50 shows current&nbsp;assets are 150% of&nbsp;current&nbsp;liabilities.&nbsp;However, showing a percentage causes confusion.&nbsp;<\/p>\n\n\n\n<p>It is correct, though&nbsp;rare, to show the value as&nbsp;1.50x or&nbsp;1.50:1. The best answer is 1.50.<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Current-ratio-key-facts\"><\/span>Current ratio key facts<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<figure class=\"wp-block-table aligncenter is-style-stripes\"><table><thead><tr><th class=\"has-text-align-center\" data-align=\"center\">Current Ratio <\/th><th class=\"has-text-align-center\" data-align=\"center\">Key Facts<\/th><\/tr><\/thead><tbody><tr><td class=\"has-text-align-center\" data-align=\"center\">Definition<\/td><td class=\"has-text-align-center\" data-align=\"center\">Ability to pay short-term debts<\/td><\/tr><tr><td class=\"has-text-align-center\" data-align=\"center\">Formula<\/td><td class=\"has-text-align-center\" data-align=\"center\">Current Assets \/ Current Liabilities<\/td><\/tr><tr><td class=\"has-text-align-center\" data-align=\"center\">Expressed<\/td><td class=\"has-text-align-center\" data-align=\"center\">As a multiple:  e.g. 1.25<\/td><\/tr><tr><td class=\"has-text-align-center\" data-align=\"center\">Financial Statement<\/td><td class=\"has-text-align-center\" data-align=\"center\">Assets: balance sheet<br>Liabilities: balance sheet<\/td><\/tr><tr><td class=\"has-text-align-center\" data-align=\"center\">Category<\/td><td class=\"has-text-align-center\" data-align=\"center\"><a href=\"https:\/\/finallylearn.com\/liquidity-ratios\/\">Liquidity Ratios<\/a><\/td><\/tr><tr><td class=\"has-text-align-center\" data-align=\"center\">Alternate Names<\/td><td class=\"has-text-align-center\" data-align=\"center\">Liquidity Ratio<br>Working Capital Ratio<\/td><\/tr><tr><td class=\"has-text-align-center\" data-align=\"center\">Alternate Formula<\/td><td class=\"has-text-align-center\" data-align=\"center\">None<\/td><\/tr><tr><td class=\"has-text-align-center\" data-align=\"center\">Interpretation<\/td><td class=\"has-text-align-center\" data-align=\"center\">Higher = less risk<br>Lower = more risk<\/td><\/tr><tr><td class=\"has-text-align-center\" data-align=\"center\">Limitations<\/td><td class=\"has-text-align-center\" data-align=\"center\">Too High = <br>inefficient and lower returns<\/td><\/tr><tr><td class=\"has-text-align-center\" data-align=\"center\">Notes<\/td><td class=\"has-text-align-center\" data-align=\"center\">Most popular liquidity ratio<\/td><\/tr><\/tbody><\/table><figcaption class=\"wp-element-caption\">Current Ratio Key Facts<\/figcaption><\/figure>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Liquidity-ratios\"><\/span>Liquidity ratios<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p><a href=\"https:\/\/finallylearn.com\/liquidity-ratios\/\">Liquidity ratios<\/a> show the company&#8217;s ability to pay its bills and maintain normal operations. Liquidity ratios include:<\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li>current ratio<\/li>\n\n\n\n<li>net working capital<\/li>\n\n\n\n<li>quick ratio<\/li>\n\n\n\n<li>cash ratio<\/li>\n<\/ol>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Alternate-names\"><\/span>Alternate names<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>There are two&nbsp;synonyms for the current ratio:&nbsp;<\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li>Working Capital Ratio<\/li>\n\n\n\n<li>Liquidity Ratio&nbsp;<\/li>\n<\/ol>\n\n\n\n<p><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Alternate-formula\"><\/span>Alternate formula&nbsp;<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>There are no alternate formulas for the current ratio.&nbsp; It is one of the few ratio formulas with no alternate formulas.&nbsp;<\/p>\n\n\n\n<p><\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Current-ratio-interpretation\"><\/span>Current ratio interpretation<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>The basic interpretation of the current ratio is:&nbsp;<\/p>\n\n\n\n<ul class=\"wp-block-list\">\n<li>Lower = Less Liquid = More Risky<\/li>\n\n\n\n<li>Higher = More Liquid = Less Risky&nbsp;<\/li>\n\n\n\n<li>Too High = Inefficient Use of Resources = Lower Returns&nbsp;<\/li>\n<\/ul>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"What-is-a-good-current-ratio\"><\/span>What is a good current ratio?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Generally, 1.50 to 2.00 are good values for the current ratio. Historically, values around 2.00 indicated adequate liquidity and stability.&nbsp; This value has decreased in recent years, with values around 1.50 now accepted as good for many firms.&nbsp;&nbsp;&nbsp;<\/p>\n\n\n\n<p>As with many ratios, \u201cgood\u201d values are industry-specific.&nbsp; Values well above 1.50 are common in some industries, while values below 1.50 may be adequate in others.&nbsp; However, higher values are always safer in an absolute sense.<\/p>\n\n\n\n<p>To illustrate, all U.S. listed companies had a median current ratio of 1.94 in 2020. <\/p>\n\n\n\n<p>For general merchandise retailers, the ratio was 1.35. However, Costco, Target, and Walmart all had current ratios around 1.00. These companies rely on strong cash flow to pay for their current debts.<\/p>\n\n\n\n<figure class=\"wp-block-table aligncenter is-style-stripes\"><table><thead><tr><th class=\"has-text-align-left\" data-align=\"left\">2020<\/th><th class=\"has-text-align-right\" data-align=\"right\">Current Ratio<\/th><\/tr><\/thead><tbody><tr><td class=\"has-text-align-left\" data-align=\"left\">Costco<\/td><td class=\"has-text-align-right\" data-align=\"right\">0.99<\/td><\/tr><tr><td class=\"has-text-align-left\" data-align=\"left\">Target<\/td><td class=\"has-text-align-right\" data-align=\"right\">1.03<\/td><\/tr><tr><td class=\"has-text-align-left\" data-align=\"left\">Walmart<\/td><td class=\"has-text-align-right\" data-align=\"right\">0.97<\/td><\/tr><tr><td class=\"has-text-align-left\" data-align=\"left\">All Retailers (median)<\/td><td class=\"has-text-align-right\" data-align=\"right\">1.35<\/td><\/tr><tr><td class=\"has-text-align-left\" data-align=\"left\">All U.S. Companies (median)<\/td><td class=\"has-text-align-right\" data-align=\"right\">1.94<\/td><\/tr><\/tbody><\/table><\/figure>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"What-if-current-ratio-is-too-low\"><\/span>What if current ratio is too low?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>Low current ratio values, even below 1.00, do not necessarily signal a financial crisis for the firm.\u00a0The ability to repay short-term obligations is determined not just by the firm\u2019s\u00a0current\u00a0assets, but also by its cash flows.<\/p>\n\n\n\n<p>Firms with high enough cash flow may be able to maintain lower current assets and still comfortably repay short-term debts.&nbsp; For example, a firm with mostly cash sales and high inventory turnover will typically have low accounts receivable and inventory balances.&nbsp; <\/p>\n\n\n\n<p>If we assume that the firm reinvests its cash inflows, then this firm will have low&nbsp;current&nbsp;assets.&nbsp; However, due to the nature of its business (cash sales and rapid inventory turnover), this firm is probably quite liquid &#8211; even if it has high&nbsp;current&nbsp;liabilities.&nbsp;<\/p>\n\n\n\n<blockquote class=\"wp-block-quote is-layout-flow wp-block-quote-is-layout-flow\">\n<p>To calculate the current ratio, see the <a href=\"https:\/\/finallylearn.com\/current-ratio-calculator\/\" data-type=\"post\" data-id=\"6852\">Current Ratio Calculator<\/a><\/p>\n<\/blockquote>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"What-if-current-ratio-is-too-high\"><\/span>What if current ratio is too high?<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>There are two important points to note regarding high values for the&nbsp;current&nbsp;ratio:&nbsp;<\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li>&nbsp;It is possible that high values indicate \u201cfalse liquidity\u201d&nbsp;<\/li>\n\n\n\n<li>Values that are \u201ctoo high\u201d impose an opportunity cost on the firm in the form of lowered returns.&nbsp;<\/li>\n<\/ol>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Limitation-false-liquidity\"><\/span>Limitation: false liquidity&nbsp;<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>The liquidity ratios all compare current assets to current liabilities in some way.&nbsp;Higher&nbsp;levels of current assets&nbsp;compared to&nbsp;current liabilities are typically interpreted as&nbsp;creating greater liquidity. However, in certain situations, this may not be true.&nbsp;<\/p>\n\n\n\n<p>Two&nbsp;of the current assets, inventory and accounts receivable,&nbsp;may be artificially high&nbsp;in&nbsp;some cases.&nbsp; Inventory may include the value of products that have little chance of being sold. This is due to obsolescence or a lack of demand in the market.&nbsp; <\/p>\n\n\n\n<p>Accounts receivable may include the value of accounts that have little chance of being collected because of age or a variety of other factors.&nbsp;&nbsp;&nbsp;<\/p>\n\n\n\n<p>In short, it is possible that the inventory and accounts receivable numbers that influence&nbsp;most of the&nbsp;liquidity ratios&nbsp;are \u201coptimistic.\u201d&nbsp; Obviously, firms should write off inventory that cannot be sold and receivables that cannot be collected. However, firms may not always do this in a timely manner.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Opportunity-cost-and-liquidity-ratios\"><\/span>Opportunity cost&nbsp;and liquidity ratios&nbsp;<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>One of the challenges&nbsp;in interpreting any of the liquidity ratios is that&nbsp;it is possible to have too much liquidity. Higher values&nbsp;for any of the&nbsp;liquidity&nbsp;ratios&nbsp;indicate more liquidity and, thus, lower risk.<\/p>\n\n\n\n<p>However, very high values may indicate&nbsp;that current assets are being managed inefficiently, thus reducing the firm&#8217;s returns.&nbsp;This is due to the opportunity cost of holding too many current assets.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Opportunity-costs-and-low-returns\"><\/span>Opportunity costs and low returns<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>The low returns that current assets generate are to blame for this opportunity cost. This is compared to more productive long-term assets.<\/p>\n\n\n\n<ol class=\"wp-block-list\">\n<li>The rate of return on \u201ctrue\u201d cash is zero.&nbsp;<\/li>\n\n\n\n<li>The return on marketable securities is typically tied to short-term interest rates. However, these rates are usually low.&nbsp;<\/li>\n\n\n\n<li>The return on inventory is typically negative. This is due to obsolescence, theft, or damage.&nbsp;<\/li>\n\n\n\n<li>The rate of return on receivables is typically negative. Some accounts will not be collected.&nbsp;<\/li>\n<\/ol>\n\n\n\n<p>Due to these low returns, firms should try to minimize&nbsp;current&nbsp;assets as much as possible given the constraints of their business models and economic reality.&nbsp;&nbsp;Obviously, firms need to hold cash and inventory.&nbsp; However, holding excess current assets leads to inefficiency and opportunity costs.&nbsp;<\/p>\n\n\n\n<h2 class=\"wp-block-heading\"><span class=\"ez-toc-section\" id=\"Opportunity-cost-example\"><\/span>Opportunity cost example<span class=\"ez-toc-section-end\"><\/span><\/h2>\n\n\n\n<p>This opportunity cost is easy to show with a simple example.&nbsp; <\/p>\n\n\n\n<p>Assume we have two firms that are completely identical except for their total current&nbsp;assets.&nbsp;Basic financial information about the firms appears below:&nbsp;<\/p>\n\n\n\n<figure class=\"wp-block-table aligncenter is-style-stripes\"><table><thead><tr><th>Financial Data<\/th><th class=\"has-text-align-right\" data-align=\"right\">Firm A<\/th><th class=\"has-text-align-right\" data-align=\"right\">Firm B<\/th><\/tr><\/thead><tbody><tr><td>Current Assets&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">$1,000&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">$3,000&nbsp;<\/td><\/tr><tr><td>Fixed Assets&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">4,000&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">4,000&nbsp;<\/td><\/tr><tr><td>Total Assets&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">5,000&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">7,000&nbsp;<\/td><\/tr><tr><td>Net Income&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">700&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">700&nbsp;<\/td><\/tr><tr><td>Current Liabilities<\/td><td class=\"has-text-align-right\" data-align=\"right\">500<\/td><td class=\"has-text-align-right\" data-align=\"right\">500<\/td><\/tr><tr><td><\/td><td class=\"has-text-align-right\" data-align=\"right\"><\/td><td class=\"has-text-align-right\" data-align=\"right\"><\/td><\/tr><tr><td>Current Ratio<\/td><td class=\"has-text-align-right\" data-align=\"right\">2.00<\/td><td class=\"has-text-align-right\" data-align=\"right\">6.00<\/td><\/tr><tr><td>ROA*<\/td><td class=\"has-text-align-right\" data-align=\"right\">14.00%&nbsp;<\/td><td class=\"has-text-align-right\" data-align=\"right\">10.00%&nbsp;<\/td><\/tr><\/tbody><\/table><figcaption class=\"wp-element-caption\">*Return on assets (ROA) = net income \/ total assets<\/figcaption><\/figure>\n\n\n\n<p>In the example above,&nbsp;Firm A has good liquidity with a current ratio of 2.00. Firm B has higher liquidity at 6.00.&nbsp;However, it is too high.&nbsp; It must hold more current assets, thus increasing its total assets. Increasing assets reduces its return on assets (ROA).&nbsp;<\/p>\n\n\n\n<p>It is difficult to determine the optimal amount of liquidity for a firm.&nbsp;&nbsp;However,&nbsp;there is a trade-off. More liquidity is safer. But, too much liquidity imposes opportunity costs on the firm through lower returns.&nbsp;<\/p>\n\n\n\n<p><\/p>\n\n\n\n<p><\/p>\n","protected":false},"excerpt":{"rendered":"<p>The current ratio estimates an entity&#8217;s ability to pay its short-term debts. The current ratio formula is current assets divided by current liabilities. A current ratio of 1.5 to 2.0 is good, and a current ratio less than 1.0 is poor.<\/p>\n","protected":false},"author":1,"featured_media":7021,"comment_status":"closed","ping_status":"closed","sticky":false,"template":"","format":"standard","meta":{"footnotes":""},"categories":[99],"tags":[],"class_list":["post-1039","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-financial-analysis"],"blocksy_meta":[],"brizy_media":[],"_links":{"self":[{"href":"https:\/\/finallylearn.com\/wp-json\/wp\/v2\/posts\/1039","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/finallylearn.com\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/finallylearn.com\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/finallylearn.com\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/finallylearn.com\/wp-json\/wp\/v2\/comments?post=1039"}],"version-history":[{"count":5,"href":"https:\/\/finallylearn.com\/wp-json\/wp\/v2\/posts\/1039\/revisions"}],"predecessor-version":[{"id":7025,"href":"https:\/\/finallylearn.com\/wp-json\/wp\/v2\/posts\/1039\/revisions\/7025"}],"wp:featuredmedia":[{"embeddable":true,"href":"https:\/\/finallylearn.com\/wp-json\/wp\/v2\/media\/7021"}],"wp:attachment":[{"href":"https:\/\/finallylearn.com\/wp-json\/wp\/v2\/media?parent=1039"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/finallylearn.com\/wp-json\/wp\/v2\/categories?post=1039"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/finallylearn.com\/wp-json\/wp\/v2\/tags?post=1039"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}