Definition

The current ratio is the liquidity ratio which is used to measure the ability of a company to pay its short term obligations. This measure is related to the company’s total assets and total liabilities. If this ratio is high, it means that company has sufficient liquidity to pay its short term liabilities.

Explanation of Current Ratio

This ratio is mainly used to give an idea about the ability of a company to repay its liabilities from its assets or income generated from the assets. It is also a tool of measuring the financial health of a company. A ratio with value 1 indicates that liabilities of a company are equal to its assets. A ratio with values less than 1 show that the company’s liabilities are greater than its assets and it will be difficult for the company to pay its liabilities. A ratio with value more than 1 indicates that the assets of the company are greater than its liabilities and company has sufficient liquidity to pay its debts easily. On the other hand, it also reflects the efficiency of an operating cycle of a company or the ability to turn its products into cash. Companies with long inventory turnover and receivables can face the liquidity problem because they are unable to alleviate their obligations.