Current ratio: Formula and examples

The current ratio is a simple liquidity metric that shows whether your company can pay its short-term obligations using its short-term assets. It compares what you own that’s convertible to cash within a year to what you owe over the same period, giving you a quick snapshot of near-term financial stability.

While no single metric tells the full story, the current ratio is often the first place finance teams, lenders, and investors look. Because it’s calculated directly from the balance sheet, it’s easy to compute and useful for spotting potential cash flow issues early.

What is the current ratio?

The current ratio is a financial metric that measures a company's ability to meet its short-term liabilities using its current assets. You calculate it by dividing current assets by current liabilities, which typically include obligations due within one year or one operating cycle, whichever is longer.

A ratio above 1 suggests the company has more current assets than current liabilities, suggesting it's well-positioned to handle short-term commitments. A ratio below 1 may indicate the need for stronger financial management to address potential liquidity challenges.

The current ratio is important because it reveals whether your company can meet its immediate financial obligations without scrambling for emergency funding. Investors use it to spot potential cash flow problems before they become serious, and lenders rely on it when deciding whether to extend credit.

As a liquidity ratio, the current ratio sits alongside other measurements such as the quick and cash ratios. It provides the broadest view of short-term financial flexibility, though each ratio offers unique insights into how well your company manages its working capital.

The current ratio formula

The current ratio formula is straightforward. You simply divide your company's current assets by its current liabilities:

Current ratio = Current assets / Current liabilities

In plain terms, a current ratio of 1.5 means you have $1.50 in short-term assets for every $1 of short-term liabilities.

The result is expressed as a number (e.g., 1.5). A higher number means stronger short-term liquidity, indicating you have more resources available to cover what you owe.

Current assets

Current assets are the resources a company expects to convert into cash or use up within a year. These are key to understanding your company's liquidity and short-term financial health. Common examples include:

• Cash and cash equivalents: Checking accounts, savings, money market funds
• Accounts receivable: Money customers owe you
• Inventory: Goods available for sale
• Prepaid expenses: Advance payments such as insurance or rent
• Marketable securities: Short-term investments you can quickly sell

These details appear on your company's balance sheet, usually under the “Current Assets” section.

Current liabilities

Current liabilities represent your company's short-term financial obligations due within one year or one operating cycle, whichever is longer. These are commitments your business must settle using its most liquid assets. Common examples include:

• Accounts payable: Money you owe suppliers and vendors
• Short-term debt: Loans or credit lines due within 12 months
• Accrued expenses: Wages, utilities, and taxes you owe but haven't paid
• Current portion of long-term debt: The slice of long-term loans due this year

This information is listed under the current liabilities section on your company's balance sheet and provides a clear picture of your immediate financial responsibilities.

How to calculate the current ratio

Calculating the current ratio involves identifying the right numbers and applying a simple formula to assess liquidity. By analyzing the balance sheet, you can quickly determine your company's ability to meet its short-term obligations.

1. Gather your financial statements

Pull your balance sheet. It lists all current assets and current liabilities in separate sections. Make sure you're working with the most recent data for an accurate picture.

2. Add up current assets

Sum cash, accounts receivable, inventory, prepaid expenses, and marketable securities. For example, a company might have $50,000 in cash, $100,000 in accounts receivable, and $50,000 in inventory for total current assets of $200,000.

3. Add up current liabilities

Sum accounts payable, short-term debt, accrued expenses, and current debt portions. Using the same example, the company might have $80,000 in accounts payable, $50,000 in short-term loans, and $20,000 in accrued expenses for total current liabilities of $150,000.

4. Divide current assets by current liabilities

Apply the formula by dividing current assets by liabilities:

Current ratio = $200,000 / $150,000 = 1.33

This calculation shows the company has $1.33 in current assets for every $1 of current liabilities, indicating a stable liquidity position with enough resources to comfortably meet short-term obligations.

Using a current ratio calculator

While the math is simple, it can sometimes be helpful to use a spreadsheet template or an online current ratio calculator. A calculator is especially helpful when you need to compare multiple companies.

Current ratio examples

Let's take a look at a couple of examples to understand how the current ratio works:

Company with strong liquidity

Imagine ACME Corp.'s current assets total $300,000. These include $100,000 in accounts receivable, $150,000 in inventory, and $50,000 in cash and cash equivalents.

On the other hand, ACME Corp.'s current liabilities amount to $200,000, consisting of $120,000 in accounts payable, $50,000 in short-term loans, and $30,000 in accrued expenses.

Here's a sample calculation for ACME Corp., showing a healthy ratio:

Using the current ratio formula, we calculate:

Current ratio = $300,000 / $200,000 = 1.5

This result shows that ACME Corp. has $1.50 in current assets for every $1 of current liabilities. A current ratio like this suggests that ACME Corp. is in a solid liquidity position, capable of covering its short-term obligations without significant financial strain.

While a ratio above 1 typically indicates financial stability, consider industry standards and the nature of the company's operations for a complete analysis. Monitoring this helps your business maintain financial health and prepare for short-term challenges.

Company with weak liquidity

Now consider ABC Inc., which has a current assets valuation of $150,000. These assets include $75,000 in accounts receivable, $50,000 in inventory, and $25,000 in cash and cash equivalents.

Meanwhile, ABC Inc.'s current liabilities total $280,000, consisting of $120,000 in accounts payable, $130,000 in short-term loans, and $30,000 in accrued expenses.

Here's an example showing ABC Inc.'s current ratio:

Using the current ratio formula, we calculate:

Current ratio = $150,000 / $280,000 = 0.54

This result shows that ABC Inc. has roughly $0.54 in current assets for every $1 of current liabilities. A low current ratio like this reveals that ABC Inc. is in a very shaky liquidity position, incapable of covering its short-term obligations without some kind of additional funding.

What is a good current ratio?

A good current ratio typically ranges between 1.5 and 2.0, showing that a company has enough current assets to cover its short-term obligations while ensuring its operations stay efficient. However, what makes a "good" ratio can vary by industry.

Here are some industry benchmarks to take into consideration:

• Retail: Due to high inventory turnover, acceptable current ratios in this industry often range from 1.0–1.5. Retail businesses use quick sales cycles to maintain liquidity, so lower ratios are common. Large retailers with fast sales cycles often operate closer to the lower end of this range.
• Manufacturing: Capital-intensive industries often aim for higher current ratios between 2.0 and 3.0 to account for large inventories and significant operating expenses
• Technology: Tech companies with minimal inventory and strong cash positions may operate effectively with current ratios around 1.5–2.0
• Utilities: These businesses tend to have stable cash flows and may have lower current ratios, often around 0.5–1.0, as their predictable revenue reduces the need for large liquid reserves

A current ratio below 1 indicates a company has fewer current assets than current liabilities, meaning it may struggle to meet short-term obligations within the next year. This signals potential liquidity problems and could raise some red flags for the company, including possible bankruptcy risk, inability to pay suppliers or employees, or forced asset sales.

What the current ratio tells you about financial health

The current ratio is a key indicator of your company's liquidity and financial health, but how you interpret it can vary based on the context.

Ratio above 1.0

You have more current assets than liabilities. You can likely cover short-term debts without issues. This generally signals financial stability and gives you flexibility to handle unexpected expenses or opportunities.

Ratio below 1.0

You may struggle to pay obligations on time. This signals potential cash flow problems and may require financing. A ratio below 1 doesn't automatically mean trouble—some industries operate successfully with lower ratios—but it warrants closer attention to your cash management.

Ratio above 2.0

A high current ratio generally indicates stronger liquidity, as the company has a greater proportion of short-term assets to cover its obligations. However, an excessively high ratio (such as over 3.0) might signal inefficiencies.

While it shows the company can cover its liabilities several times over, it could also point to underutilized assets, suboptimal financing, or poor working capital management. To assess whether your company's ratio is appropriate, compare it with industry benchmarks.

Current ratio vs. other liquidity ratios

The current ratio is just one of several liquidity metrics to evaluate your business's financial health. Comparing it with other metrics can provide a deeper understanding of the company's ability to handle its short-term obligations and maintain operational efficiency.

Quick ratio

The quick ratio, also known as the acid-test ratio, measures liquidity by excluding inventory from current assets. Since inventory may take longer to convert into cash, the quick ratio focuses on liquid assets such as cash, accounts receivable, and marketable securities you can quickly turn into cash.

While the current ratio considers all current assets, the quick ratio provides a more conservative view of your business’s ability to meet short-term obligations. The quick ratio is particularly valuable for retail companies, manufacturers with seasonal inventory, or during economic uncertainty, when inventory might be harder to liquidate.

Cash ratio

The cash ratio measures liquidity by dividing cash and cash equivalents by current liabilities. Cash and cash equivalents include cash and demand deposits, such as money market funds.

The cash ratio is a stricter liquidity metric than the current ratio. Unlike the current ratio, it doesn't include accounts receivable and inventory, giving a clear view of a company's immediate ability to settle obligations using only cash and near-cash assets. This metric can help assess your business's financial health during periods of uncertainty.

Operating cash flow ratio

The operating cash flow ratio uses operating cash flow instead of current assets. It shows whether your operations generate enough cash to cover obligations, providing insight into actual cash generation rather than accounting values on the balance sheet.

This ratio is particularly useful because it reflects real cash movement rather than accounting values that may include non-cash items or assets that are difficult to liquidate quickly.

Why use multiple ratios?

Comparing multiple ratios provides better insight because no single ratio tells the complete story. Each examines different aspects of financial health, such as liquidity, profitability, and leverage, and can reveal blind spots in others.

For example, your company might show strong profitability but poor liquidity, or an excellent current ratio masking inventory problems that the quick ratio exposes.

Limitations of the current ratio

While the current ratio offers valuable insights into short-term liquidity, it has a few drawbacks that can mislead financial analysis.

The ratio captures only one moment in time and doesn't reflect the timing or predictability of when current assets will convert to cash or when current liabilities become due.

• Timing blind spot: The ratio captures only one moment in time and doesn't reflect the timing or predictability of when current assets will convert to cash or when current liabilities become due
• Inventory inflation: Slow-moving or obsolete inventory can artificially inflate your ratio, making liquidity appear stronger than it actually is
• Industry variance: A "healthy" ratio differs significantly between sectors, making cross-industry comparisons misleading
• Point-in-time snapshot: Only captures one moment and doesn't show trends or seasonality. Companies with cyclical business patterns may show artificially strong or weak ratios depending on when the measurement occurs.
• Manipulation potential: Companies can time payments or collections to improve ratios before reporting, and hidden obligations such as operating leases, pending lawsuits, or contingent liabilities can significantly affect a company's true liquidity position

For a more comprehensive liquidity assessment, consider pairing the current ratio with the quick ratio, cash ratio, and working capital metrics. These additional measures provide deeper insight into cash conversion speed and actual cash generation capabilities, particularly for businesses with inventory-heavy balance sheets or irregular seasonal patterns.

How to improve your current ratio

A healthy current ratio gives you flexibility and peace of mind, but getting there takes some practical action. Whether you're looking to strengthen your financial position or make smarter business decisions, here's how to put this ratio to work:

Reduce unnecessary expenses

Cut discretionary spending and review recurring costs to preserve cash on hand. Audit subscriptions, renegotiate contracts, and eliminate redundant services to keep more cash in your current assets.

Collect receivables more quickly

Invoice immediately after delivery and follow up promptly on overdue accounts receivable. Consider offering early payment discounts to customers to accelerate cash collection and reduce the time money sits in receivables.

Negotiate extended payment terms

Ask suppliers for longer payment windows to reduce immediate cash outflow pressure. Extended payment terms effectively give you more time to convert assets to cash before obligations come due.

Liquidate excess inventory

Sell slow-moving stock—even at a discount—to convert it to cash. Reduce inventory levels through sales or markdowns, and implement better inventory management to prevent future buildup.

Refinance short-term debt

Convert short-term loans to long-term debt. This moves obligations out of current liabilities, immediately improving your current ratio while giving you more breathing room on repayment schedules. You can also use excess cash to pay down high-interest short-term obligations.

A strong current ratio provides your business with the financial flexibility to weather uncertainty and capitalize on opportunities.

Track cash flow in real time with Ramp's automated spend visibility and forecasting

Short-term liquidity challenges often stem from poor visibility into cash flow and delayed financial data. You can't manage what you can't see, and when spend data lives across disconnected systems or sits in manual spreadsheets, it's nearly impossible to assess your current cash position or forecast what's coming next.

Ramp's accounting automation software gives you complete, real-time visibility into every dollar moving through your business. All transactions are captured, coded, and categorized automatically as they happen, so you always know exactly where you stand. Ramp's AI learns your accounting patterns and applies the right GL codes, departments, and dimensions across all required fields—eliminating the lag time between when spend occurs and when it hits your books.

Here's how Ramp improves short-term liquidity management:

• Real-time transaction visibility: See every purchase, reimbursement, and bill payment as it posts, so you can track cash outflows without waiting for month-end
• Automated cash flow forecasting: Ramp analyzes your spending patterns and upcoming commitments to project future cash needs, helping you identify potential shortfalls before they become problems
• Instant budget tracking: Monitor spend against budgets in real time across departments, projects, and cost centers, so you can course-correct before overspending impacts liquidity
• Automated accruals and amortization: Ramp posts accruals and amortizes prepaid expenses automatically, ensuring your financial statements reflect true cash obligations in each period

Try a demo to see how Ramp helps finance teams assess and improve short-term liquidity with automated spend visibility.