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Current ratio definition

Description

Current ratio indicates companies’ ability to cover its’ short-term debts. All the data needed to calculate this ratio can be easily collected from the balance sheet. It is very important to notice that current ratio is the most general liquidity ratio, which doesn’t show the quality of current assets.

Current ratio is mostly important for company’s creditors, whose interest is to determine company’s potential to meet its short-term obligations. This ratio is quite similar to the acid-test ratio and cash ratio. As while evaluating company‘s liquidity it is recommended to assess all those ratios.

Norms and limitations

A ratio of 1.2 to 2 is generally considered acceptable. From 2 to 3 – good.

However it is a must to consider company’s industry. Higher value indicates ineffective use of company’s asset. It is important to the owners of the company, as it indicates that there are some missteps in management activities. Whereas lower value shows that there might be some difficulties in covering obligations.

Formula

current ratio

Current liabilities, also known as short-term debts, indicate debts that must be covered in a period of 12 months.

Current asset is a value that represents those assets of the company that are reasonably expected to be converted into cash within the period of 12 months: inventories, accounts receivable, cash and others.