Current ratio

A ratio compares two figures to reveal something neither number shows on its own. The current ratio compares what a company owns that can be turned into cash within a year against what it owes within that same year.

The current ratio measures whether a company can cover its near-term obligations. It divides current assets by current liabilities, showing how many dollars of short-term resources exist for every dollar of short-term debt.

The formula is: Current assets / Current liabilities.

A current ratio above 1 means current assets exceed current liabilities, a basic sign of short-term solvency. A ratio below 1 means near-term obligations exceed what could readily be turned into cash, a warning sign, though not necessarily a crisis if cash flow is strong and reliable. A very high current ratio is not automatically a good thing either, it can mean the company is sitting on excess inventory or receivables that aren't being put to productive use.

Because current assets include inventory, which can be slower and less certain to convert into cash than cash itself or receivables, analysts often pair the current ratio with the quick ratio, a stricter version that excludes inventory, to get a fuller picture of short-term liquidity.