Current Ratio Formula, Example, and Interpretation

These are future expenses that have been paid in advance that haven’t yet been used up or expired. Generally, prepaid expenses that will be used up within one year are initially reported on the balance sheet as a current asset. As the amount expires, the current asset is reduced and the amount of the reduction is reported as an expense on the income statement. The current ratio is a very common financial ratio to measure liquidity. A high current ratio is not beneficial to the interest of shareholders.

What are Current Assets?

It measures a company’s ability to cover its short-term obligations (liabilities that are due within a year) with current assets. To assess this ability, the current ratio compares the current total assets of a company to its current total liabilities. What counts as a good current ratio will depend on the company’s industry and historical performance. Current ratios over 1.00 indicate that a company’s current assets are greater than its current liabilities, meaning it could more easily pay of short-term debts. A current ratio of 1.50 or greater would generally indicate ample liquidity.

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If all current liabilities of Apple had been immediately due at the end of 2021, the company could have paid all of its bills without leveraging long-term assets. In the first case, the trend of the current ratio over time would be expected to harm the company’s valuation. Meanwhile, an improving current ratio could indicate an opportunity to invest in an undervalued stock amid a turnaround. This article and related content is the property of The Sage Group plc or its contractors or its licensors (“Sage”). Please do not copy, reproduce, modify, distribute or disburse without express consent from Sage.This article and related content is provided as a general guidance for informational purposes only.

When Should You Use the Quick Ratio or the Current Ratio?

Examples of current liabilities include accounts payable, wages payable, and the current portion of any scheduled interest or principal payments. Both current assets and current liabilities are listed on a company’s balance sheet. Let’s look at some examples of companies with high and low current ratios. You can find these numbers on a company’s balance sheet under total current assets and total current liabilities. Some finance sites also give you the ratio in a list with other common financials, such as valuation, profitability and capitalization. A more conservative measure of liquidity is the quick ratio — also known as the acid-test ratio — which compares cash and cash equivalents only, to current liabilities.

What Does the Current Ratio Measure?

An investor or analyst looking at this trend over time would conclude that the company’s finances are likely more stable, too. Changes in the current ratio over time can often offer a clearer picture of a company’s finances. A company that seems to have an acceptable current ratio could be trending toward a situation in which it will struggle to pay its bills. Conversely, a company that may appear to be struggling now could be making good progress toward a healthier current ratio.

• A more conservative measure of liquidity is the quick ratio — also known as the acid-test ratio — which compares cash and cash equivalents only, to current liabilities.
• Please do not copy, reproduce, modify, distribute or disburse without express consent from Sage.This article and related content is provided as a general guidance for informational purposes only.
• Ratios in this range indicate that the company has enough current assets to cover its debts, with some wiggle room.
• The higher the number, the more liquid and/or stable a company.

The current ratio does not inform companies of items that may be difficult to liquidate. For example, consider prepaid assets that a company has already paid for. It may not be feasible to consider this when factoring in true liquidity, as this amount of capital may not be refundable and already committed. A current ratio of 1.1 means a company can pay off its short-term debt a little over one time with its current assets. Larger market cap companies tend to have a bigger list of current assets than the penny stocks I trade.

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It could have a ton of long-term debt maturing in the near future. The following data has been extracted from the financial statements of two companies – company A and company B. Understanding the Current Ratio empowers investors and analysts to make informed decisions, enabling them to navigate the intricate world of finance with confidence. Whether you’re why are notes and footnotes important in accounting chron com a seasoned pro or a newcomer to the world of investing, grasping the essentials of the Current Ratio is a critical step toward financial acumen. My Accounting Course  is a world-class educational resource developed by experts to simplify accounting, finance, & investment analysis topics, so students and professionals can learn and propel their careers.