current ratio
A liquidity ratio that measures a company's ability to pay short-term obligations, calculated by dividing current assets by current liabilities.
Example
“A current ratio of 2.0 means the company has $2 in current assets for every $1 of current liabilities — a healthy buffer.”
Memory Tip
Current RATIO = can you pay your CURRENT (near-term) bills? Above 1.0 = yes.
Why It Matters
Understanding the current ratio helps you assess whether a company or household has enough liquid resources to cover immediate bills and obligations. A healthy current ratio indicates financial stability and reduces the risk of bankruptcy or cash flow problems in the near term.
Common Misconception
Many people believe that a higher current ratio is always better, but an extremely high ratio can actually signal that a company is holding too much cash and not investing efficiently in growth opportunities. The ideal current ratio typically falls between 1.5 and 3.0 depending on the industry.
In Practice
Suppose Company A has current assets of 500,000 dollars and current liabilities of 250,000 dollars, resulting in a current ratio of 2.0. This means the company has 2 dollars in short-term assets for every 1 dollar of short-term obligations, suggesting it can comfortably pay its bills over the next year.
Etymology
CURRENT (short-term, due within one year) RATIO. The ratio of CURRENT assets to CURRENT liabilities.
Common Misspellings
Small business accounting made simple
Related Terms
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See Also
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