________ ratio is calculated by dividing current assets by current liabilities.

The current ratio is one way investors can evaluate a company's short-term liquidity.

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What Is the Current Ratio and How Is It Interpreted?

The current ratio is one of the most popular liquidity metrics used by investors and analysts to determine how likely a company is to be able to cover its debts and payments in the short term. It is very similar to the quick ratio, but it includes all current assets in its calculation instead of just the most liquid.

Because the current ratio compares short-term assets directly to short-term liabilities, a ratio of 1 or more indicates that a company would be able to cover all of its short-term liabilities using assets that are intended to be turned into cash within the next year or so. A ratio of less than 1, on the other hand, can indicate that a company may not be quite solvent enough to cover all of its upcoming debts were they all to come due at once.

It’s important to keep in mind that the current ratio is a snapshot of a moment in time, so it can change rapidly as accounts like payables and receivables fluctuate in balance, so it should always be taken with a grain of salt. 

If short-term liabilities exceed short-term assets by only a small amount, a company may still be in fine shape. If a company’s ratio lingers significantly below 1 for a long time, however, this may indicate a problem with the business’ short-term solvency.

How Is the Current Ratio Calculated?

The current ratio is calculated by dividing the value of a company’s current assets (those likely to be converted to cash or paid out within a year) by the value of its current liabilities (those coming due within a year)

Typically, current assets include cash, cash equivalents, marketable securities, and other miscellaneous liquid assets; while current liabilities usually include upcoming tax payments, accounts payable, notes payable, and other short-term debts (if coming due within a year).

Current Ratio Formula

CR = Current Assets / Current Liabilities

Current Ratio Example: Apple (NASDAQ: AAPL)

Let’s calculate Apple’s current ratio as of March 27th, 2021. To calculate the current ratio, we’ll include all current assets in the numerator. These figures can be found on Apple’s financial filings from that date. The figures below are in millions of dollars.

Current assets: $121,465
Current liabilities: $106,385

CR = Liquid Assets / Current Liabilities
CR = $121,465 / $106,385
CR = 1.14

Because the ratio came out above 1, it looks like Apple was in a healthy position to cover all of its upcoming liabilities as of late March 2021. 

Current Ratio vs. Quick Ratio: What’s the Difference?

The current and quick ratios are extremely similar. Both compare a company’s current assets to its current liabilities. That being said, the current ratio includes all current assets, whereas the quick ratio only includes the most liquid among them.

Since assets feature in the numerator of both ratios but the current ratio includes more total assets (and the ratios have the same denominator), a company’s current ratio should always be higher than its quick ratio. 

Which Assets Are Included in Each Ratio?

What Is a Good Current Ratio?

A current ratio above 1 is good because it indicates that a company is in a healthy position to cover all of its upcoming payments using its current assets. That being said, a current ratio too high above one (e.g., 2.9) might indicate that a company isn’t making efficient use of its current assets by using them to invest in expansion, development, hiring, or other practices that could help grow the value of the business over time.

Ideally, a company should have enough current assets to outweigh its current liabilities by a reasonable margin, but not so many that they are languishing in accounts instead of being reinvested in growth or operations. 

What Are the Limitations of the Current Ratio?

While the current ratio offers investors a convenient way to compare the short-term liquidity of various companies they are considering investing in, it doesn’t always give an accurate picture of every company’s true current liquidity.

The current ratio assumes, for example, that inventory will always be turned into cash within a year. This may be true for many companies, but in certain industries and situations, inventory isn’t always that liquid. Since the quick ratio doesn’t include inventory in its calculation, it may be a better liquidity indicator in some situations.

Similarly, not all companies have stable sales over the course of each year. Some businesses make money seasonally, so their ratios would be inflated during high-sales periods and deflated during the off-season.

Further, different industries have very different liquidity norms, so comparing the liquidity ratio of tech company to that of a fruit company may not provide meaningful insight into how liquid each company is within its market segment. Liquidity metrics like the quick and current ratios are most useful in comparing companies of relatively similar size within a particle industry. 

What does the ratio of current assets current liabilities show?

How is quick ratio calculated?

How is cash ratio calculated?

How is liquidity ratio calculated?