What is current ratio?
Definition of current ratio
The current ratio, sometimes referred to as the ‘working capital ratio’, is a liquidity ratio that measures whether a business has enough resources to pay its short-term debts or debts due within one year. It shows how a company can maximise the current assets on its balance sheet to cover its current debt and other payables.
How to calculate the current ratio
The formula for calculating the current ratio is:
current ratio = current assets / current liabilities
A ratio of less than one suggests that the business is not in the best position to pay its debts. Between 1 and 3 suggests that the business has enough cash to pay its debts.
A significant decline in the current ratio from one period to the next may indicate liquidity issues. Comparing your ratio with competitors and the industry norms to can give you a good perspective on your own situation.
Got questions? Ask Emily!
FreeAgent's Chief Accountant Emily Coltman is available to answer your questions in the comments.