What Is Current Ratio? Formula, Ideal Range, and What It Tells You
The current ratio is a widely used financial metric that evaluates a company’s ability to pay off its short-term obligations using its short-term assets. In simple terms, it answers the question: can the business meet its upcoming dues with the resources it already holds?
This ratio gives a snapshot of a company’s liquidity and is particularly useful for investors, creditors, and business owners concerned about financial accounting strength.
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Formula and How to Calculate It
The formula for calculating the current ratio is straightforward:
Current Ratio = Current Assets ÷ Current Liabilities
Current assets may include cash, inventory, receivables, and short-term investments. Current liabilities typically include accounts payable, short-term loans, and accrued expenses.
For example, if a company has ₹8,00,000 in current assets and ₹4,00,000 in current liabilities:
Current Ratio = ₹8,00,000 ÷ ₹4,00,000 = 2.0
This means the company has ₹2 available for every ₹1 it owes in the short term—indicating good liquidity.
Explore More: Best Accounting Software to Track Ratios
What Is Considered a Good Current Ratio?
The ideal current ratio can differ across industries, but in general:
- 1.5 to 2.0: Considered healthy—strong enough to cover debts without tying up excess capital.
- Below 1: Indicates potential liquidity risks—company may struggle to pay short-term debts.
- Above 3: Could suggest underutilization of assets—cash or inventory not being efficiently used.
Context is key: a grocery store might function well with a higher ratio, whereas a SaaS company might get by with a lower one.
Also Read: Golden Rules of Accounting
Current Ratio vs. Quick Ratio
The current ratio and quick ratio (also known as the acid-test ratio) are both used to assess short-term financial strength—but with a slight difference in asset treatment.
| Aspect | Current Ratio | Quick Ratio |
|---|---|---|
| Includes Inventory? | Yes | No |
| Measures Liquidity? | Broad (all current assets) | Conservative (liquid assets only) |
| Best Used When | Inventory is quickly sold | Inventory takes longer to convert |
Suppose a company has ₹10,00,000 in current assets (₹4,00,000 in inventory) and ₹5,00,000 in liabilities:
- Current Ratio = 2.0
- Quick Ratio = 1.2
The current ratio looks strong, but the quick ratio gives a more cautious picture when we remove inventory.
Check This Out: Inventory Management Software for Accurate Ratios
Conclusion
The current ratio is a vital indicator of a company’s short-term financial health. It provides insight into liquidity and helps stakeholders evaluate whether the company can meet its obligations.
However, a good ratio depends on business type, industry norms, and asset turnover. Use it along with other metrics—like Types of Vouchers or the accounting principles—to get a full picture of financial performance.
I am a Chartered Accountant with more than five years of experience in the accounting field. My areas of expertise include GST, income tax, and audits. I am passionate about sharing knowledge through blogs and articles, as I believe that learning is a lifelong journey. My goal is to provide valuable insights and simplify financial matters for individuals and business owners alike.
