Evaluating a company’s financial health can be difficult without the right metrics. Current Ratio is an important concept to understand and apply to your business. Investors, analysts, managers, and business owners can gain greater insight to the health of their company’s short-term financial obligations by using Current Ratio along with other helpful accounting metrics.<\/p>\n\n\n\n
In this post, we\u2019ll explore what is Current Ratio, how to calculate it, and how to interpret the results.<\/p>\n\n\n\n
Current Ratio measures the ability of a company to pay it’s short-term liabilities with its current assets. Short-term refers to liabilities due within one year and current assets includes assets expected to be converted into cash within one year. Essentially, the question you are hoping to solve is – Could your company settle all of its short-term debts today by only using its short-term assets? In even simpler terms, the Current Ratio measures your company’s liquidity to cover short-term debt.<\/p>\n\n\n\n
Current Ratio = Current Assets \/ Current Liabilities<\/em><\/p>\n\n\n\n Current Assets<\/p>\n\n\n\n Current Liabilities<\/p>\n\n\n\n Benjamin’s owns a small business that sells cell phones cases via a retail store. He’s unsure how well it is really doing. The revenue is increasing each month, but he’s also adding new costs. His main goal is for the small business to grow conservatively without putting it at risk due to a sudden economic downtown. <\/p>\n\n\n\n Let’s take a look at Benjamin’s small business.<\/p>\n\n\n\n Current Assets: $150,000<\/p>\n\n\n\n Current Liabilities: $50,000<\/p>\n\n\n\n This means Benjamin’s small business has a Current Ratio of 3.0 ($150,000 \/ $50,000). Another way to think of this is Benjamin’s small business has $3 in current assets for every $1 in current liabilities. This is a higher than normal Current Ratio for most businesses. Benjamin’s small business has enough available liquidity to invest in new growth opportunities and\/or increase inventory. In fact, his cell phone case business is likely missing opportunities by not utilizing this liquidity better.<\/p>\n\n\n\n While a good\/bad Current Ratio varies by industry and company lifetime, in general most businesses should fall within 1-2. <\/p>\n\n\n\n Every business is different and it’s vital to understand your full financial story. Things like seasonality and changes in purchasing patterns can affect Current Ratio calculations. <\/p>\n\n\n\n Many businesses have large swings in their seasonality with months of high sales and months of low sales. The Current Ratio of your business might look low in September, but be stable in January. Charting your Current Ratio monthly is a great way to see trends and put your mind at ease when seasonality affects your business.<\/p>\n\n\n\nSimple Example of Current Ratio<\/h2>\n\n\n\n
Good vs Bad Current Ratio<\/h2>\n\n\n\n
Limitations of Current Ratio<\/h2>\n\n\n\n