Current Ratio

Current ratio is a measure of a company's ability to meet its short-term liabilities and is calculated by dividing current assets by current liabilities. Current assets are made up of cash and cash equivalents ('near cash'), accounts receivable and inventory, while current liabilities are the sum of short-term loans and accounts payable. The current ratio's normal range is between 0.5 and 2.0, but this liquidity ratio must be interpreted with caution. A high ratio could indicate that the company is sitting on too much cash, that it is owed a lot of money by its customers or that it needs to operate with huge amounts of inventory. A low ratio does not necessarily mean the company is a risky creditor. It could mean the company operates in an industry where cash payment is standard, such as restaurants, which typically have little or no accounts receivable, in an industry that operates without much inventory such as most service sector companies, or an industry in which customers pay slowly, such as the building sector.

See also: Quick Ratio