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.
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
Explore All BUSY Calculators for Easy GST Compliance
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.
Frequently Asked Questions
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How do you calculate the current ratio?The current ratio is calculated using the formula:
Current Ratio = Current Assets ÷ Current Liabilities
It measures a company's ability to pay short-term obligations. BUSY provides real-time reports that help calculate this ratio instantly from your updated balance sheet data. -
What is a good current ratio?A good current ratio is typically around 1.5 to 2. It means the business has enough assets to cover short-term liabilities. A very high ratio may indicate under-utilized assets, while a low ratio suggests liquidity issues. BUSY helps monitor this through easy-to-read financial reports.
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What does a current ratio of less than 1 indicate?A current ratio below 1 means current liabilities are greater than current assets, signaling potential short-term cash flow problems. It may raise red flags for creditors. BUSY enables you to track this with regular updates to help you act before it affects operations.
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Why is the current ratio important?The current ratio helps assess a business's short-term financial strength. It shows whether the company can pay its bills on time. BUSY makes it easy to calculate and review the ratio regularly so that you can manage liquidity and avoid working capital issues.