What is the current ratio?
The current ratio measures a company's ability to pay its short-term obligations using its short-term assets. It is calculated by dividing total current assets by total current liabilities. A ratio above 1.0 means the business has more liquid assets than near-term obligations.
What is a good current ratio for a business?
A current ratio between 1.5 and 2.0 is generally considered healthy for most businesses. A ratio below 1.0 signals potential liquidity risk. A ratio above 3.0 may indicate the business is holding too much cash or inventory that could be deployed more efficiently.
How is the current ratio different from the quick ratio?
The current ratio includes all current assets, including inventory and prepaid expenses. The quick ratio (also called the acid-test ratio) excludes these less-liquid assets. For businesses with significant inventory, the quick ratio provides a more conservative liquidity assessment.
Do lenders care about the current ratio?
Yes. Many bank loan agreements include current ratio covenants, requiring borrowers to maintain a minimum ratio (often 1.25x or 1.5x). Falling below the covenant triggers a technical default, allowing the lender to demand repayment. Monitoring your current ratio monthly is essential for businesses with credit facilities.