Series 65: The Current Ratio

The Current Ratio

The current ratio is a measure of a company’s ability to meet its short-term debt obligations out of its most liquid assets (those easily converted into cash). It draws its name from the fact that the ratio compares what accountants refer to as a company’s current assets to its current liabilities (or debts). In its most basic form, the current ratio can be written as follows:

A company’s current assets are those that can be converted to cash easily within the coming 12-month period without a significant decrease in value. This would naturally include all cash and bank account balances, as well as inventory and short-term receivables. A receivable is a fancy way of saying “money owed to the company by someone else,” and short-term means that they can expect to collect on it in the next 12 months. A company’s current liabilities are the amounts of debt the company will be expected to repay in the next 12 months.

So, a better way to understand the current ratio is by using the following formula:

Here’s an example of how the ABC Company’s current ratio of 2.0 was calculated based on the following amounts