Current ratio formula
Current Ratio = Current Assets / Current Liabilities. Current assets include cash, trade debtors, stock and prepayments. Current liabilities include trade creditors, tax liabilities, short-term loans and accruals.
Interpreting the current ratio
A ratio above 1.0 means current assets exceed current liabilities. The business has more short-term assets than obligations, which is generally positive.
A ratio below 1.0 means current liabilities exceed current assets. This does not necessarily mean the business is insolvent, but it does indicate that additional financing may be needed to meet upcoming obligations.
- Below 1.0: potential liquidity concern, additional financing likely required
- 1.0 to 1.5: adequate, though limited buffer
- 1.5 to 2.0: healthy for most sectors
- Above 2.0: potentially holding excessive cash or underperforming assets
Frequently Asked Questions
Why does the current ratio vary by industry?
Different sectors have different asset structures. Retailers typically hold more stock relative to debtors, while service businesses may hold very little stock. Industry-specific benchmarks give more meaningful context than generic targets.