Current Ratio Analysis

Understanding Current Ratio

The Current Ratio is a liquidity ratio that measures a company's ability to pay short-term obligations or those due within one year. It tells investors and analysts how a company can maximize the current assets on its balance sheet to satisfy its current debt and other payables.

Current Ratio Formula:

Current Ratio = Current Assets / Current Liabilities

Why Current Ratio Matters:

• Measures a company's ability to pay short-term obligations
• Indicates the financial health of a company
• Helps in comparing liquidity between companies within the same industry
• Used by creditors to assess short-term lending risk

Interpreting Current Ratio:

• A ratio of 1 or more indicates that the company has enough current assets to cover its current liabilities
• A ratio below 1 suggests potential liquidity problems
• Generally, a current ratio between 1.5 and 3 is considered healthy
• A very high ratio might indicate inefficient use of assets

Limitations of Current Ratio:

• Does not consider the quality or liquidity of individual current assets
• Can be manipulated by management near reporting dates
• May not be suitable for comparing companies across different industries
• Does not account for timing of cash flows within the year

While the Current Ratio is a valuable metric for assessing liquidity, it should be used in conjunction with other financial measures for a comprehensive view of a company's financial health.