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Current ratio

Current ratio  (also known as  working capital ratio ) is a popular tool to evaluate short-term solvency position of a business. Short-term solvency refers to the ability of a business to pay its short-term obligations when they become due. Short term obligations (also known as current liabilities ) are the liabilities payable within a short period of time, usually one year.

A higher current ratio indicates strong solvency position of the entity in question and is, therefore, considered better.

Current ratio is computed by dividing total current assets by total current liabilities of the business. This relationship can be expressed in the form of following formula or equation:

Above formula comprises of two components i.e., current assets and current liabilities. Both of these components should be available from the entity’s balance sheet . Some examples of current assets and current liabilities are listed below:

Some common examples of current assets are given below:

• Marketable securities
• Accounts receivables/debtors
• Inventories/stock
• Bills receivable
• Short-term totes receivable
• Prepaid expenses

Some common examples of current liabilities are given below:

• Accounts payable/creditors
• Bills payable
• Short-term notes payable
• Short term bonds payable
• Interest payable
• Unearned revenues
• current portion of long term debt

On December 31, 2016, the balance sheet of Marshal company shows the total current assets of $1,100,000 and the total current liabilities of $400,000. Your are required to compute current ratio of the company.

Current ratio = Current assets/Current liabilities = $1,100,000/$400,000 = 2.75 times

The current ratio is 2.75 which means the company’s currents assets are 2.75 times more than its current liabilities.

Significance and interpretation

Current ratio is a useful test of the short-term-debt paying ability of any business. A ratio of 2:1 or higher is considered satisfactory for most of the companies but analyst should be very careful while interpreting it.  Simply computing the ratio does not disclose the true liquidity of the business because a high current ratio may not always be a green signal. It requires a deep analysis of the nature of individual current assets and current liabilities. A company with high current ratio may not always be able to pay its current liabilities as they become due if a large portion of its current assets consists of slow moving or obsolete inventories. On the other hand, a company with low current ratio may be able to pay its current obligations as they become due if a large portion of its current assets consists of highly liquid assets i.e., cash, bank balance, marketable securities and fast moving inventories. Consider the following example to understand how the composition and nature of individual current assets can differentiate the liquidity position of two companies having same current ratio figure.

Liquidity comparison of two or more companies with same current ratio

We may find situations where two or more companies have the same current ratio figures but their real liquidity position is far different from each other. It happens because of the quality and nature of individual items that make up the total current assets of the companies. Consider the following example to understand this point in more detail:

The following data has been extracted from the financial statements of two companies – company A and company B.

Both company A and company B have the same current ratio (2:1). Do both the companies have equal ability to pay its short-term obligations? The answer to this question is a “no” because company B is likely to have difficulties in paying its short-term obligations. Most of its current assets consist of inventory which might not be quickly convertible into cash. The company A, on the other hand, is likely to pay its current obligations as and when they become due because a large portion of its current assets consists of cash and receivables. Accounts receivable are generally considered more liquid assets in nature and thereby have a better chance to be quickly converted into cash than inventories.

The above analysis reveals that the two companies might actually have different liquidity positions even if both have the same current ratio number. While determining a company’s real short-term debt paying ability, an analyst should therefore not only focus on the current ratio figure but also consider the composition of current assets.

Limitations of current ratio

Current ratio suffers from a number of considerable limitations and, therefore, can’t be applied as the sole index of liquidity. Some major limitations are given below:

1. Different ratio in different parts of the year:

The volume and frequency of trading activities have high impact on the entities’ working capital position and hence on their current ratio number. Many entities have varying trading activities throughout the year due to the nature of industry they belong. The current ratio of such entities significantly alters as the volume and frequency of their trade move up and down. In short, these entities exhibit different current ratio number in different parts of the year which puts both usability and reliability of the ratio in question.

2. Issues in inter-firm comparison:

Financial ratios are often made part of inter-firm comparison – a comparison of operating performance and financial status of two or more similar commercial entities working in the same industry, primarily conducted to learn and achieve a better business performance. To compare the current ratio of two companies, it is necessary that both of them use the same inventory valuation method. For example, comparing current ratio of two companies would be like comparing apples with oranges if one uses FIFO while other uses LIFO cost flow assumption for costing/valuing their inventories. The analyst would, therefore, not be able to compare the ratio of two companies even in the same industry.

3. Just a test of quantity, not quality:

Current ratio is a number which simply tells us the quantity of current assets a business holds in relation to the quantity of current liabilities it is obliged to pay in near future. Since it reveals nothing in respect of the assets’ quality, it is often regarded as crued ratio. For example, an entity with a favorable current ratio may still be at liquidity risk if it currently lacks on cash to settle its short-term liabilities and a bigger portion of its total current assests is composed of work in process inventories and slow moving stocks which generally require a longer period of time to bring cash in business.

4. Window dressing and manipulation:

Current ratio can be easily manipulated by equal increase or equal decrease in current assets and current liabilities numbers. For example, if current assets of a company are $10,000 and current liabilities are $5,000, the current ratio would be 2 : 1 as computed below:

$10,000 : $5,000 = 2 : 1

Now If both current assets and current liabilities are reduced by $1,000, the ratio would be increased to 2.25 : 1 as computed below:

$9,000 : $4,000 = 2.25 : 1

Similarly if we increase both the elements by $1,000, the ratio would be decreased to 1.83 : 1 as computed below:

$11,000 : $6,000 = 1.83 : 1

However in order to minimize the impact of above mentioned limitations and to conduct a meaningful and reliable liquidity analysis of a business, the current ratio can be used in conjunction with many other ratios like inventory turnover ratio , receivables turnover ratio , average collection period , current cash debt coverage ratio , and quick ratio etc. These ratios are helpful in testing the quality and liquidity of a number of individual current assets and together with current ratio can provide much better insights into the company’s short-term financial solvency.

Computating current assets or current liabilities when the ratio number is given

Students may come across examination questions or home work problems in which the examiner or tutor provideds a current ratio number along with some additional information pertaining to a business entity and asks them to work out either total current assets or total current liabilities figure. For example, he may provide current ratio and one of the total current assets or total current liabilities figure and ask the students to calculate the other one. There is no difficulty involved in computations like this, because we can work out either of the two figures just by rearranging the components of formula given above. Consider the two examples given below:

T & D company’s current ratio is 2.5 for the most recent period. If total current assets of the company are $7,500,000, what are total current liabilities?

Current ratio = Current assets/Current liabilities or Current liabilities = Current assets/Current ratio = $7,500,000/2.5 = $3,000,000

If Marbel Inc’s current ratio is 1.4 and total current liabilities are $8,000,000, what are its total current assets?

Current ratio = Current assets/Current liabilities or Current assets = Current liabilities × Current ratio = $8,000,000 × 1.4 = $11,200,000

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How to Calculate (And Interpret) The Current Ratio

Janet Berry-Johnson, CPA

Reviewed by

March 10, 2022

This article is Tax Professional approved

All businesses have bills to pay. Your ability to pay them is called "liquidity," and liquidity is one of the first things that accountants and investors will look at when assessing the health of your business.

I am the text that will be copied.

The current ratio (also known as the current asset ratio , the current liquidity ratio , or the working capital ratio ) is a financial analysis tool used to determine the short-term liquidity of a business. It takes all of your company’s current assets, compares them to your short-term liabilities, and tells you whether you have enough of the former to pay for the latter.

In other words, the current ratio is a good indicator of your company’s ability to cover all of your pressing debt obligations with the cash and short-term assets you have on hand. It’s one of the ways to measure the solvency and overall financial health of your company.

Here, we’ll go over how to calculate the current ratio and how it compares to some other financial ratios.

How do you calculate the current ratio?

You calculate your business’s overall current ratio by dividing your current assets by your current liabilities .

To do this, you’ll need to get familiar with your balance sheet —as one of the three primary financial statements your business produces, your balance sheet helps you get a sense of the big picture and serves as a historical record of a specific moment in time.

Current assets (also called short-term assets) are cash or any other asset that will be converted to cash within one year . You can find them on the balance sheet, alongside all of your business’s other assets.

The five major types of current assets are:

Cash and cash equivalents . These include cash and short-term securities that your business can quickly sell and convert into cash, like treasury bills, short-term government bonds, and money market funds.

Marketable securities . These typically have a maturity period of one year or less, are bought and sold on a public stock exchange, and can usually be sold within three months on the market. Examples include common stock, treasury bills, and commercial paper.

Accounts receivable . This account is used to keep track of any money customers owe for products or services already delivered and invoiced for.

Inventory . This includes all the goods and materials a business has stored for future use, like raw materials, unfinished parts, and unsold stock on shelves.

Prepaid expenses . These are future expenses that have been paid in advance that haven’t yet been used up or expired. Generally, prepaid expenses that will be used up within one year are initially reported on the balance sheet as a current asset. As the amount expires, the current asset is reduced and the amount of the reduction is reported as an expense on the income statement.

Your current liabilities (also called short-term obligations or short-term debt) are:

• Any outstanding bill payments
• Short-term loans
• Any other kind of short-term liability that your business must pay back within the next 12 months

You can find them on your company’s balance sheet, alongside all of your other liabilities.

Current liabilities do not include long-term debt, like bonds, lease obligations, and long-term notes payable.

Here are a few common examples of current liabilities:

• Credit card debt
• Notes payable that mature within one year
• Wages payable
• Deferred revenue
• Accounts payable
• Accrued liabilities (also known as accrued expenses) like dividend, income tax, and payroll

What is the current ratio formula?

You calculate the current ratio by dividing your company’s current assets by your current liabilities, i.e.:

Current ratio = total current assets / total current liabilities

Let’s imagine that your fictional company, XYZ Inc., has $15,000 in current assets and $22,000 in current liabilities. Its current ratio would be:

Current ratio = $15,000 / $22,000 = 0.68

That means that the current ratio for your business would be 0.68.

A company with a current ratio of less than one doesn’t have enough current assets to cover its current financial obligations. XYZ Inc.’s current ratio is 0.68, which may indicate liquidity problems.

But that’s also not always the case.

A low current ratio could also just mean that you’re in an industry where it’s normal for companies to collect payments from customers quickly but take a long time to pay their suppliers, like the retail and food industries.

Or it could mean that your company is very good at keeping inventory low. (Remember: inventory is included in current assets.)

A high current ratio, on the other hand, may indicate inefficient use of assets, or a company that’s hanging on to excess cash instead of reinvesting it in growing the business.

What is a good current ratio?

As with many other financial metrics, the ideal current ratio will vary depending on the industry, operating model, and business processes of the company in question.

In general, a current ratio between 1.5 and 3 is considered healthy. Ratios lower than 1 usually indicate liquidity issues, while ratios over 3 can signal poor management of working capital.

The definition of a “good” current ratio also depends on who’s asking. In many cases, lenders prefer high current ratios, since it indicates that the company won’t have any issues paying the creditor back, while investors may take a high current ratio as a signal of operational inefficiencies.

Current vs. quick ratio

The quick ratio (also sometimes called the acid-test ratio) is a more conservative version of the current ratio.

The quick ratio differs from the current ratio in that it leaves inventory out and keeps the three other major types of current assets: cash equivalents, marketable securities, and accounts receivable.

So the equation for the quick ratio is:

Quick ratio = (cash equivalents + marketable securities + accounts receivable) / current liabilities

Because inventory levels vary widely across industries, in theory, this ratio should give us a better reading of a company’s liquidity than the current ratio. But it’s important to put it in context.

A lower quick ratio could mean that you’re having liquidity problems, but it could just as easily mean that you’re good at collecting accounts receivable quickly.

Similarly, a higher quick ratio doesn’t automatically mean you’re liquid, especially if you encounter unexpected problems collecting receivables

Current vs. cash ratio

Looking for an even purer (in theory) liquidity test? You want the cash ratio.

The cash ratio takes accounts receivable out of the equation, leaving you with only cash equivalents and marketable securities to cover your current liabilities:

Cash ratio = (cash equivalents + marketable securities) / current liabilities

If you have a high cash ratio, you’re sitting pretty. It’s the most conservative measure of liquidity and, therefore, the most reliable, industry-neutral method of calculating it.

Advanced ratios

Financial analysts will often also use two other ratios to calculate the liquidity of a business: the current cash debt coverage ratio and the cash conversion cycle (CCC) .

The current cash debt coverage ratio is an advanced liquidity ratio. It measures how capable a business is of paying its current liabilities using the cash generated by its operating activities (i.e., money your business brings in from its ongoing, regular business activities).

The cash conversion cycle (CCC) is a metric that expresses the time (in days) it takes for a company to convert its investments in inventory and other resources into cash flows from sales.

These calculations are fairly advanced, and you probably won’t need to perform them for your business, but if you’re curious, you can read more about the current cash debt coverage ratio and the CCC .

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Current Ratio

Step-by-Step Guide to Understanding Current Ratio

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What is Current Ratio?

The Current Ratio is a measure of a company’s near-term liquidity position, or more specifically, the short-term obligations coming due within one year.

Often used alongside the quick ratio, the current ratio measures if a company can meet its short-term obligations using its short-term assets on the present date.

• The current ratio is a financial metric that measures the liquidity of a company by comparing the current assets belonging to a company to its current liabilities to determine if the liquid assets are sufficient to meet its short-term obligations coming due within twelve months (or one-year).
• The current ratio formula is the current assets of a company divided by its current liabilities.
• A current ratio of around 1.5x to 3.0x is considered to be healthy, whereas a current ratio below 1.0x is deemed a red flag that implies the near-term liquidity of the company presents risks.
• The current ratio is different from the quick ratio because the metric is less conservative because the formula includes all current assets, rather than only those confirmed to be truly liquid.

Table of Contents

How to Calculate Current Ratio

Current ratio formula, current ratio calculation example, what is a good current ratio, what are the limitations of current ratio, current ratio vs. quick ratio: what is the difference, current ratio calculator, 1. balance sheet assumptions, 2. working capital calculation example, 3. current ratio calculation example.

The current ratio is categorized as a liquidity ratio , since the financial metric assesses how financially sound the company is in relation to its near-term liabilities .

Liquidity ratios generally have a near-term focus, hence the two main inputs are current assets and current liabilities.

• Current Assets → Cash and Cash Equivalents, Marketable Securities, Accounts Receivable (A/R), Inventory
• Current Liabilities → Accounts Payable (A/P), Accrued Expense, Deferred Revenue (D/R), Short-Term Debt (<12 Month)

The current ratio reflects a company’s capacity to pay off all its short-term obligations, under the hypothetical scenario that short-term obligations are due right now.

The formula to calculate the current ratio divides a company’s current assets by its current liabilities.

Since the current ratio compares a company’s current assets to its current liabilities, the required inputs can be found on the balance sheet .

Often, the current ratio tends to also be a useful proxy for how efficient the company is at working capital management.

Suppose a company has the following balance sheet data:

Current Assets:

• Cash = $25 million
• Marketable Securities = $20 million
• Accounts Receivable (A/R) = $10 million
• Inventory = $60 million

Current Liabilities:

• Accounts Payable (A/P) = $55 million
• Short-Term Debt = $60 million

With that said, the required inputs can be calculated using the following formulas.

• Current Assets = $25 million + $20 million + $10 million + $60 million = $115 million
• Current Liabilities = $55 million + $60 million = $115 million

For the last step, we’ll divide the current assets by the current liabilities.

• Current Ratio = $115 million ÷ $115 million = 1.0x

The current ratio of 1.0x is right on the cusp of an acceptable value, since if the ratio dips below 1.0x, that means the company’s current assets cannot cover its current liabilities.

If the ratio were to drop below the 1.0x “floor”, raising external financing would become urgent.

The range used to gauge the financial health of a company using the current ratio metric varies on the specific industry.

For instance, supermarket retailers typically have low current ratios considering their business model (and free cash flows) are essentially a function of their ability to raise more debt to fund asset purchases (i.e. increases debt on B/S ), as well as pushing back supplier/vendor payments (i.e. increasing accounts payable )

As a general rule of thumb, a current ratio in the range of 1.5 to 3.0 is considered healthy.

• Current Ratio >1.5x → The company has sufficient current assets to pay off its current liabilities
• Current Ratio = 1.0x → The company has sufficient current assets to meet its current liabilities, however, there is no margin for error (i.e. no “cushion”)
• Current Ratio <1.0x → The company has insufficient current assets to pay off its current liabilities

However, a current ratio <1.0 could be a sign of underlying liquidity problems, which increases the risk to the company (and lenders if applicable).

Tracking the current ratio can be viewed as “worst-case” scenario planning (i.e. liquidation scenario) — albeit, the company’s business model may just require fewer current assets and comparatively more current liabilities.

Here, the company could withstand a liquidity shortfall if providers of debt financing see the core operations are intact and still capable of generating consistent cash flows at high margins.

But a higher current ratio is NOT necessarily always a positive sign — instead, a ratio in excess of 3.0x can result from a company accumulating current assets on its balance sheet (e.g. cannot sell inventory to customers).

While under a liquidation scenario, a higher amount of asset collateral is perceived positively, most companies focus on forward-looking performance like free cash flow (FCF) generation and profit margins , although everything is linked to one another in some ways.

The limitations of the current ratio – which must be understood to properly use the financial metric – are as follows.

• Minimum Cash Balance → One shortcoming of the metric is that the cash balance includes the minimum cash amount required for working capital needs. Without the minimum cash on hand for operations to continue, as usual, the business cannot continue to run if its cash were to dip below this level — e.g. the company is struggling to collect owed cash payments from customers that paid on credit.
• Restricted Cash → Likewise, the cash balance could contain restricted cash, which is not freely available for use by the business and is instead held for a specific purpose.
• Illiquid Short-Term Investments → Next, the inclusion of short-term investments that cannot be liquidated in the markets easily could also have been included — i.e. low liquidity and cannot sell without selling at a loss at a substantial discount.
• Bad A/R (Uncollectible) → The last drawback to the current ratio that we’ll discuss is the accounts receivable amount can include “Bad A/R”, which is uncollectible customer payments, but management refuses to recognize it as such.

Another practical measure of a company’s liquidity is the quick ratio , otherwise known as the “acid-test” ratio.

The formula to compute the quick ratio is as follows.

In comparison to the current ratio, the quick ratio is considered a more strict variation due to filtering out current assets that are not actually liquid — i.e. cannot be sold for cash immediately.

By adjusting the numerator to include solely highly liquid assets that can truly be converted into cash in <90 days with a high degree of certainty, the quick ratio is a more conservative measure of liquidity.

We’ll now move to a modeling exercise, which you can access by filling out the form below.

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Suppose we’re tasked with analyzing the liquidity of a company with the following balance sheet data in Year 1.

• Cash and Cash Equivalents = $20 million
• Marketable Securities = $15 million
• Accounts Receivable (A/R) = $25 million
• Inventory = $65 million
• Accounts Payable: $45 million
• Short-Term Debt: $80 million

Putting the above together, the total current assets and total current liabilities each add up to $125m, so the current ratio is 1.0x as expected.

The company has just enough current assets to pay off its liabilities on its balance sheet.

As for the projection period – from Year 2 to Year 4 – we’ll use a step function for each B/S line item, with the Year 1 figures serving as the starting point.

Our assumptions for the changes in working capital line items are as follows.

• Cash and Cash Equivalents = +$5 million/Year
• Marketable Securities = +$5 million/Year
• Accounts Receivable (A/R) = +$3 million/Year
• Inventory = +$2 million/Year
• Accounts Payable (A/P) = –$3 million/Year
• Short-Term Debt = –$2 million/Year

Clearly, the company’s operations are becoming more efficient, as implied by the increasing cash balance and marketable securities (i.e. highly liquid, short-term investments), accounts receivable , and inventory.

By dividing the current assets balance of the company by the current liabilities balance in the coinciding period, we can determine the current ratio for each year.

From Year 1 to Year 4, the current ratio increases from 1.0x to 1.5x.

• Current Ratio – Year 1 = $125 million ÷ $125 million = 1.0x
• Current Ratio – Year 2 = $140 million ÷ $120 million = 1.2x
• Current Ratio – Year 3 = $155 million ÷ $115 million = 1.3x
• Current Ratio – Year 4 = $170 million ÷ $110 million = 1.5x

Note the growing A/R balance and inventory balance require further diligence, as the A/R growth could be from the inability to collect cash payments from credit sales .

The increase in inventory could stem from reduced customer demand, which directly causes the inventory on hand to increase — which can be good for raising debt financing (i.e. more collateral), but a potential red flag.

Therefore, applicable to all measures of liquidity, solvency , and default risk, further financial due diligence is necessary to understand the real financial health of our hypothetical company.

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What is the Current Ratio?

Current ratio formula, example of the current ratio formula, download the free current ratio formula template.

• Current Ratio Formula - What are Current Assets?
• Current Ratio Formula - What are Current Liabilities?

Why Use the Current Ratio Formula?

Additional resources.

Current Assets / Current Liabilities

The current ratio, also known as the working capital ratio, measures the capability of a business to meet its short-term obligations that are due within a year. The ratio considers the weight of total current assets versus total current liabilities .

It indicates the financial health of a company and how it can maximize the liquidity of its current assets to settle debt and payables. The current ratio formula (below) can be used to easily measure a company’s liquidity.

The Current Ratio formula is:

Current Ratio = Current Assets / Current Liabilities

If a business holds:

• Cash = $15 million
• Marketable securities = $20 million
• Inventory = $25 million
• Short-term debt = $15 million
• Accounts payables = $15 million

Current assets = 15 + 20 + 25 = 60 million

Current liabilities = 15 + 15 = 30 million

Current ratio = 60 million / 30 million = 2.0x

The business currently has a current ratio of 2, meaning it can easily settle each dollar on loan or accounts payable twice. A rate of more than 1 suggests financial well-being for the company. There is no upper end on what is “too much,” as it can be very dependent on the industry, however, a very high current ratio may indicate that a company is leaving excess cash unused rather than investing in growing its business.

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Current Ratio Template

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Current Ratio Formula – What are Current Assets?

Current assets are resources that can quickly be converted into cash within a year’s time or less. They include the following:

• Cash – Legal tender bills, coins, undeposited checks from customers, checking and savings accounts, petty cash
• Cash equivalents – Corporate or government securities with 90 days or less maturity
• Marketable securities – Common stock, preferred stock, government and corporate bonds with a maturity date of 1 year or less
• Accounts receivable – Money owed to the company by customers and that is due within a year – This net value should be after deducting an allowance for doubtful accounts (bad credit)
• Notes receivable – Debt that is maturing within a year
• Other receivables – Insurance claims, employee cash advances, income tax refunds
• Inventory – Raw materials, work-in-process, finished goods, manufacturing/packaging supplies
• Office supplies – Office resources such as paper, pens, and equipment expected to be consumed within a year
• Prepaid expenses – Unexpired insurance premiums, advance payments on future purchases

Current Ratio Formula – What are Current Liabilities?

Current liabilities are business obligations owed to suppliers and creditors, and other payments that are due within a year’s time. This includes:

• Notes payable – Interest and the principal portion of loans that will become due within one year
• Accounts payable or Trade payable – Credit resulting from the purchase of merchandise, raw materials, supplies, or usage of services and utilities
• Accrued expenses – Payroll taxes payable, income taxes payable, interest payable, and anything else that has been accrued for but an invoice is not received
• Deferred revenue – Revenue that the company has been paid for that will be earned in the future when the company satisfies revenue recognition requirements

This current ratio is classed with several other financial metrics known as liquidity ratios. These ratios all assess the operations of a company in terms of how financially solid the company is in relation to its outstanding debt. Knowing the current ratio is vital in decision-making for investors, creditors, and suppliers of a company. The current ratio is an important tool in assessing the viability of their business interest.

Other important liquidity ratios include:

• Acid-Test Ratio
• Quick Ratio

Below is a video explanation of how to calculate the current ratio and why it matters when performing an analysis of financial statements .

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Thank you for reading this guide to understanding the Current Ratio Formula. To keep educating yourself and advancing your finance career, these CFI resources will be helpful:

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• Current Ratio Calculator
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• Liquidation Value Template
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• Current Ratio

Home › Finance › Financial Ratio Analysis › Current Ratio

The current ratio is a  liquidity and  efficiency ratio  that measures a firm’s ability to pay off its short-term liabilities with its current assets. The current ratio is an important measure of liquidity because short-term liabilities are due within the next year.

This means that a company has a limited amount of time in order to raise the funds to pay for these liabilities. Current assets like cash, cash equivalents, and marketable securities can easily be converted into cash in the short term. This means that companies with larger amounts of current assets will more easily be able to pay off current liabilities when they become due without having to sell off long-term, revenue generating assets.

The current ratio is calculated by dividing current assets by current liabilities. This ratio is stated in numeric format rather than in decimal format. Here is the calculation:

GAAP  requires that companies separate current and long-term assets and liabilities on the  balance sheet . This split allows investors and creditors to calculate important ratios like the current ratio. On U.S. financial statements, current accounts are always reported before long-term accounts.

The current ratio helps investors and creditors understand the liquidity of a company and how easily that company will be able to pay off its current liabilities. This ratio expresses a firm’s current debt in terms of current assets. So a current ratio of 4 would mean that the company has 4 times more current assets than current liabilities.

A higher current ratio is always more favorable than a lower current ratio because it shows the company can more easily make current debt payments.

If a company has to sell of fixed assets to pay for its current liabilities, this usually means the company isn’t making enough from operations to support activities. In other words, the company is losing money. Sometimes this is the result of poor collections of accounts receivable.

The current ratio also sheds light on the overall debt burden of the company. If a company is weighted down with a current debt, its cash flow will suffer.

Charlie’s Skate Shop sells ice-skating equipment to local hockey teams. Charlie is applying for loans to help fund his dream of building an indoor skate rink. Charlie’s bank asks for his balance sheet so they can analysis his current debt levels. According to Charlie’s balance sheet he reported $100,000 of current liabilities and only $25,000 of current assets. Charlie’s current ratio would be calculated like this:

As you can see, Charlie only has enough current  assets  to pay off 25 percent of his current liabilities. This shows that Charlie is highly leveraged and highly risky. Banks would prefer a current ratio of at least 1 or 2, so that all the current liabilities would be covered by the current assets. Since Charlie’s ratio is so low, it is unlikely that he will get approved for his loan.

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Shaun Conrad is a Certified Public Accountant and CPA exam expert with a passion for teaching. After almost a decade of experience in public accounting, he created MyAccountingCourse.com to help people learn accounting & finance, pass the CPA exam, and start their career.

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Current Ratio Calculation

Written by True Tamplin, BSc, CEPF®

Reviewed by subject matter experts.

Updated on April 16, 2023

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Table of contents, current ratio definition.

The current ratio is a liquidity ratio that is used to calculate a company's ability to meet its short-term debt and obligations, or those due in a single year, using assets available on its balance sheet .

It is also known as working capital ratio. A current ratio of one or more is preferred by investors.

A current ratio less than one is an indicator that the company may not be able to service its short-term debt.

On the other hand, a current ratio greater than one can also be a sign that the company has too much unsold inventory or cash on hand.

Current Ratio Formula

Current assets refers to the sum of all assets that will be used or turned to cash in the next year.

This list includes cash, inventory, and accounts receivables . Current liabilities refers to the sum of all liabilities that are due in the next year.

This list includes wages, accounts payable and mortgage payments and loans.

For example, if a company has $100,000 in current assets and $150,000 in current liabilities , then its current ratio is 0.6.

What Does the Current Ratio Measure?

Current ratios can vary depending on industry, size of company, and economic conditions.

Industries with predictable, recurring revenue , such as consumer goods, often have lower current ratios while cyclical industries, such as construction, have high current ratios. Even within an industry, current ratios can differ between companies.

For example, supplier agreements can make a difference to the number of liabilities and assets. A large retailer like Walmart may negotiate favorable terms with suppliers that allow it to keep inventory for longer periods and have generous payment terms or liabilities.

What Is a Good Current Ratio?

During times of economic growth , investors prefer lean companies with low current ratios and ask for dividends from companies with high current ratios.

But, during recessions , they flock to companies with high current ratios because they have current assets that can help weather downturns.

Current ratios are not always a good snapshot of company liquidity because they assume that all inventory and assets can be immediately converted to cash. This may not always be the case, especially during economic recessions.

In such cases, acid-test ratios are used because they subtract inventory from asset calculations to calculate immediate liquidity.

Current Ratio Calculation FAQs

What is the current ratio.

The current ratio is a liquidity ratio that is used to calculate a company’s ability to meet its short-term debt and obligations, or those due in a single year, using assets available on its balance sheet.

What is the formula for the Current Ratio?

The formula for the current ratio is: Current Ratio = Current Assets / Current Liabilities

What is a good current ratio?

A current ratio of one or more is preferred by investors.

What's an example of current ratio?

For example, if a company has $100,000 in current assets and $150,000 in current liabilities, then its current ratio is 0.6.

How reliable is the current ratio?

Current ratios are not always a good snapshot of company liquidity because they assume that all inventory and assets can be immediately converted to cash. This may not always be the case, especially during economic recessions. In such cases, acid-test ratios are used because they subtract inventory from asset calculations to calculate immediate liquidity.

About the Author

True Tamplin, BSc, CEPF®

True Tamplin is a published author, public speaker, CEO of UpDigital, and founder of Finance Strategists.

True is a Certified Educator in Personal Finance (CEPF®), author of The Handy Financial Ratios Guide , a member of the Society for Advancing Business Editing and Writing, contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University , where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website or view his author profiles on Amazon , Nasdaq and Forbes .

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Current Ratio Formula, Calculation and Examples

The current ratio formula and calculation is an example of liquidity ratios used to determine a company’s ability to pay off current debt obligations without raising external capital. The current ratio, quick ratio , and operating cash flow ratio are all types of liquidity ratios.

This article will discuss the current ratio formula, interpretation, and calculation with examples. But first of all, let’s look at the definition and how it is used.

What is the current ratio?

Therefore, the current ratio measures a company’s short-term liquidity with respect to its available assets. Current ratios measure the ability of a company to pay its short-term or current liabilities (debts and payables) with its short-term or current assets, such as cash, inventory, and receivables. The ratio is an indication of a firm’s liquidity.

The current ratio in finance compares the company’s current assets to its current liabilities, thus, evaluating whether a company has enough resources to meet its short-term obligations. This ratio is called a current ratio because all current assets and liabilities are included in the current ratio equation. This is different from other liquidity ratios like the quick ratio and cash ratio.

The quick ratio, unlike the current ratio formula, only considers assets that can be converted to cash in a short period of time. So, it excludes inventory and prepaid expense assets in the calculation. While cash ratio as the name implies measures the ability of the company to settle its short-term liabilities using only cash and cash equivalents. Therefore, a simple on how to find current ratio in accounting is to divide the company’s current assets by its current liabilities.

Furthermore, the current ratios that are acceptable will vary from industry to industry. So, the ratio derived from the current ratio calculation is considered acceptable if it is in line with the industry average current ratio or slightly higher.

Conversely, a current ratio may indicate a higher risk of distress or default, if it is lower than the industry average. For investors, a very high current ratio may not be a good sign. This is because a company having a very high current ratio compared to its peer group may mean that the management might not be using the company’s assets or its short-term financing facilities efficiently.

If the current liabilities of a company are more than its current assets, the current ratio will be less than 1. It is interpreted that a current ratio of less than 1 may mean that the company likely has problems meeting its short-term obligations.

Nevertheless, some kinds of businesses function with a current ratio of less than 1. For instance, a company’s current ratio can comfortably remain less than 1, if inventory turns into cash much faster than the accounts payable become due. The sale of inventory will generate substantially more cash than its value on the balance sheet if it is sold for more than the cost of acquiring it. More so, low current ratios are also understandable for businesses that can collect cash from customers long before they need to pay their suppliers.

Interpretation

Interpreting current ratio as good or bad would depend on the industry average current ratio. The current ratio interpretation of a ratio greater than 1 shows that the current assets of the company are greater than its liabilities. This can be seen as a desirable situation for investors and creditors. Furthermore, the current ratio analysis that gives a ratio that is equal to 1 shows that the current assets of the company equate to its current liabilities, indicating that the company has current assets that are just enough to settle short-term obligations.

However, interpreting a current ratio of less than 1 shows that the company’s current assets are less than its current liabilities. This could be a problem as it indicates that the company does not have enough current assets to settle its short-term obligations.

Therefore, in several cases, a current ratio greater than 1 means that the company has the financial resources to remain solvent in the short term, whereas a company with a current ratio less than 1 may not have the capital on hand to pay off its short-term obligations. However, the current ratio analysis is usually not a complete representation of a company’s short-term liquidity or longer-term solvency.

Therefore, it is only when the ratio is placed in the context of what has been historically normal for the company and its peer group that it can be a useful metric of a company’s short-term solvency. Current ratios can also offer more insight when calculated repeatedly over several periods. This is because calculating the current ratio at just one point in time could show that the company can’t pay off all of its current debts, but it doesn’t necessarily mean that the company won’t be able to settle the debts when the payments are due.

Theoretically, we interpret current ratios as the higher the current ratio, the more the ability of the company to pay its obligations because it has a larger amount of short-term asset value compared to the value of its short-term liabilities.

Nevertheless, a company with a very high current ratio, say 3.0 compared to its peer group may not necessarily mean that the company can cover its current liabilities three times. It could mean that the management may not be using the company’s current assets or its short-term financing facilities efficiently. It could be an indication that the company’s working capital is not properly managed and is not securing financing very well.

Current ratio formula

The formula for current ratio in accounting is expressed as:

Current ratio = Current Assets / Current Liabilities

The current assets and current liabilities are listed on the company’s balance sheet. These current assets include items such as accounts receivable, cash, inventory, and other current assets (OCA) that are expected to be liquidated or turned into cash within a year. The current liabilities, on the other hand, include wages, accounts payable, short-term debts, taxes payable, and the current portion of long-term debt.

Current ratio calculation

The current ratio calculation is done by comparing the current assets of the company to its current liabilities. How to find the current ratio is to divide the company’s current assets by the current liabilities of the company.

How do you calculate current ratio?

Example 1: how to calculate current ratio from balance sheet.

Here is an example of how to calculate current ratio from the balance sheet using the excerpt from the Apple balance sheet for the fiscal year of 2020  below:

From the excerpt of Apple, Inc. (AAPL) 2020 balance sheet, we can see that for the fiscal year (FY) ended September 26, 2020, Apple had total current assets of $143,713,000,000 and total current liabilities of $105,392,000,000.

How to compute current ratio in balance sheet

Using the current ratio formula:

Calculating current ratio will be:

Current ratio = $143,713,000,000 / $105,392,000,000 = 1.36

Current ratio interpretation example : Apple Inc. (AAPL) having a current ratio of 1.36 indicates that the company has more than enough to cover its current liabilities if these liabilities were all theoretically due immediately and all its current assets could be converted into cash.

How to calculate current ratio example 2

Company X and Company Y are two leading competitors operating in the consumer electronics manufacturing sector. Calculate the current ratio of Company X and Company Y based on the figures given as appeared on their balance sheets for the fiscal year ending in 2020.

How to calculate the current ratio

Using the current ratio equation:

Calculating current ratio for Company X will be:

Current ratio = $105,000 / $130,000 = 0.807

Calculating current ratio for Company Y will be :

Current ratio interpretation example : In the current ratio calculation done for Company X and Company Y, it is seen that the two companies both have a current ratio value of 0.807 which is less than 1, indicating that these companies may not have enough current assets to settle their short-term obligations. However, even though these two companies seem similar, Company Y is likely in a more liquid and solvent position based on the following observations from the balance sheet:

• Company X has much more inventory than Company Y, which may be harder to turn into cash in the short term. It is possible that this inventory is overstocked or unwanted, which eventually may reduce its value on the balance sheet.
• Company Y has more cash than Company X. Cash is the most liquid asset, and Company X even have more accounts receivable, which could be collected more quickly than liquidating inventory.
• In regard to assets, even though the total value of current assets is the same for both companies, Company Y is in a more liquid, solvent position.

Also, for the liabilities, even though the current liabilities of Company X and Y sums up the same value, they are still very different because Company X has more accounts payable, whereas Company Y has a greater amount in short-term notes payable.

More investigation may be needed because there is a probability that the accounts payable will have to be paid before the entire balance of the notes-payable account. More so, Company X has fewer wages payable, which is the liability most likely to be paid in the short term.

However, an investor can look deeper into the details of a current ratio comparison of these companies by evaluating other liquidity ratios that are more narrowly focused than the current ratio, such as the quick ratio.

How to find current ratio example 3

What will be the current ratio analysis of a tech firm with the following details in its balance sheet:

How to calculate the current ratio of tech firm

Using the formula for current ratio:

Calculating the current ratio for the firm will be:

Current ratio = $87,000,000 / $40,000,000 = 2.175

Current ratio interpretation example : It means that this tech firm has a current ratio of 2.1 indicating that it can easily settle $1 of its debts or accounts payable twice. This suggests financial well-being for the firm.

How to increase current ratio

Reconfigure debt, reduce the company’s expenses, enhance asset management.

How to increase current ratio is to repay or restructure debt. Companies can explore ways they can re-amortize existing term loans and change the interest charges from lenders. This can effectively delay debt payments and drop off the current ratio. Companies can also negotiate for longer payment cycles whenever they can. This can enable the company to shift short-term debt into a long-term loan, thus, reducing its impact on liquidity.

One of the ways to increase the current ratio is to reduce expenses. The budget of the company should be reviewed carefully to see where some line items can be reduced. Also, considering limiting personal draws on the business can help in achieving a better current ratio. If possible, the business can finance or delay capital purchases that need a significant outlay of cash. This is because when the business spends operating funds on major expenses, the current ratio will draw below 1.

Enhancing asset management in the company can help increase the current ratio of the company. For instance, with a sweep account, the cash on hand of the company can earn interest while remaining available for operating expenses. These accounts sweep excess cash into an interest-bearing account and then return this excess cash to the operating account when it’s time to pay bills.

The company can also consider selling unused capital assets that don’t produce a return. This cash infusion would increase the short-term assets column, which, in turn, increases the current ratio of the company. There are some liabilities that do not bring funds into the business that can be converted to cash.

Furthermore, if outstanding accounts payable have reduced the liquidity of the company, the company can consider amplifying efforts to collect on these debts. After purchase, the company can issue invoices as quickly as possible, establishing clear payment terms at the outset such as late fees and interest on past-due balances. Companies can conduct a close review of the business’ accounts payable process and look for inefficiencies that delay payments and prevent prompt collections.

Limitations of the current ratio formula

The current ratio formula has its limitations. It is only useful when comparing two companies in the same industry because inter-industrial business operations differ substantially. Hence, comparing the current ratios of companies across different industries may not lead to productive insight. Therefore, the current ratio is not as helpful as the quick ratio in determining liquidity.

Another disadvantage of using the current ratio formula is its lack of specificity. This is because the ratio includes all the assets that may not be easily liquidated such as inventory and prepaid expenses. Moreso, the current ratio can be manipulated by management. For instance, an equal increase in current assets and liabilities will reduce the current ratio while an equal decrease in current assets and liabilities will increase the ratio.

Compared with the quick ratio

The current ratio and quick ratio are both types of liquidity ratios. However, there is a significant difference between the current vs quick ratio. When comparing the quick ratio vs current ratio, the quick ratio is more conservative than the current ratio formula.

The quick ratio evaluates the liquidity of a company and in the calculation, the inventory and other current assets that are more difficult to turn into cash are excluded. The ratio only considers the most liquid assets on the balance sheet of the company. The current ratio formula, on the other hand, considers all current assets including the inventory and prepaid expense assets. Theoretically, the current ratio formula is not as helpful as the quick ratio formula in determining liquidity.

What does the current ratio inform you about a company?

What is a good current ratio?

What is a good current ratio for a company?

Is a high current ratio good?

How is the current ratio calculated?

Is a higher current ratio better?

Is the current ratio a percentage?

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Current ratio: What it is and how to calculate it

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The current ratio shows a company’s ability to meet its short-term obligations. The ratio is calculated by dividing current assets by current liabilities. An asset is considered current if it can be converted into cash within a year or less, while current liabilities are obligations expected to be paid within one year.

Investors can use this type of liquidity ratio to make comparisons with a company’s peers and competitors. Ultimately, the current ratio helps investors understand a company’s ability to cover its short-term debts with its current assets.

Why the current ratio matters

You’ll want to consider the current ratio if you’re investing in a company. When a company’s current ratio is relatively low, it’s a sign that the company may not be able to pay off its short-term debt when it comes due, which could hurt its credit ratings or even lead to bankruptcy. 

For example, a company’s current ratio may appear to be good, when in fact it has fallen over time, indicating a deteriorating financial condition. But a too-high current ratio may indicate that a company is not investing effectively, leaving too much unused cash on its balance sheet.

The current ratio should be placed in the context of the company’s historical performance and that of its peers. A current ratio can be better understood by looking at how it changes over time. 

The current ratio is part of what you need to understand when investing in individual stocks , but those investing in mutual funds or exchange-trade funds needn’t worry about it.

How to calculate the current ratio

You can calculate the current ratio by dividing a company’s total current assets by its total current liabilities. Again, current assets are resources that can quickly be converted into cash within a year or less, including cash, accounts receivable and inventories.

Current liabilities include accounts payable, wages, accrued expenses, accrued interest and short-term debt.

The formula is:

Current ratio: Current assets / Current liabilities

Sample current ratios

Let’s look at some examples of companies with high and low current ratios. You can find these numbers on a company’s balance sheet under total current assets and total current liabilities. Some finance sites also give you the ratio in a list with other common financials, such as valuation, profitability and capitalization. You’ll find the current ratio with other liquidity ratios.

• General Electric’s (GE) current assets in December 2021 were $65.5 billion; its current liabilities were $51.95 billion, making its current ratio 1.26.
• Target (TGT)’s 2022 current ratio was 0.99: its current assets were $21.57 billion and its current liabilities were $21.75 billion.
• Intel (INTC) at year-end 2023 had $43.27 billion in current assets and $28.05 billion in current liabilities, for a high 1.54 current ratio.

What is a good current ratio?

The ideal current ratio varies by industry. However, an acceptable range for the current ratio could be 1.0 to 2. Ratios in this range indicate that the company has enough current assets to cover its debts, with some wiggle room. A current ratio lower than the industry average could mean the company is at risk for default, and in general, is a riskier investment.

However, special circumstances can affect the meaningfulness of the current ratio. For example, a financially healthy company could have an expensive one-time project that requires outlays of cash, say for emergency building improvements. Because buildings aren’t considered current assets, and the project ate through cash reserves, the current ratio could fall below 1.00 until more cash is earned.

Similarly, companies that generate cash quickly, such as well-run retailers, may operate safely with lower current ratios. They may borrow from suppliers (increasing accounts payable) and actually receive payment from their customers before the money is due to those suppliers. For example, Walmart had a 0.83 current ratio as of January 2024. In this case, a low current ratio reflects Walmart’s strong competitive position.

The best long-term investments manage their cash effectively, meaning they keep the right amount of cash on hand for the needs of the business.

What is a bad current ratio?

A current ratio below 1.0 suggests that a company’s liabilities due in a year or less are greater than its assets. A low current ratio could indicate that the company may struggle to meet its short-term obligations.

However, similar to the example we used above, special circumstances can negatively affect the current ratio in a healthy company. For instance, imagine Company XYZ, which has a large receivable that is unlikely to be collected or excess inventory that may be obsolete. Both circumstances could reduce the current ratio at least temporarily.

Current ratio vs. quick ratio vs. debt-to-equity

Other measures of liquidity and solvency that are similar to the current ratio might be more useful, depending on the situation. For instance, while the current ratio takes into account all of a company’s current assets and liabilities, it doesn’t account for customer and supplier credit terms, or operating cash flows.

A more conservative measure of liquidity is the quick ratio — also known as the acid-test ratio — which compares cash and cash equivalents only, to current liabilities. In contrast, the current ratio includes all of a company’s current assets, including those that may not be as easily converted into cash, such as inventory, which can be a misleading representation of liquidity.

To measure solvency, which is the ability of a business to repay long-term debt and obligations, consider the debt-to-equity ratio. This ratio compares a company’s total liabilities to its total equity. It measures how much creditors have provided in financing a company compared to shareholders and is used by investors as a measure of stability. A highly leveraged company is generally a riskier investment.

Bottom line

The current ratio is just one indicator of financial health. Like most performance measures, it should be taken along with other factors for well-contextualized decision-making.

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Current Ratio: Meaning, Formula and an Example

Current Ratio: this article explains the Current Ratio in a practical way. The article starts with the general definition and meaning of the current ratio, followed by the formula that belongs to it, and a practical example. You will also find practical tips to get started with calculating the current ratio for your organisation. Enjoy reading!

What is the Current Ratio? The meaning

The current ratio (CR) is a calculation formula and liquidity indicator that indicates to what extent an organization can repay current liabilities with short term assets. This ratio is also known as liquidity ratio or cash solvency ratio .

Current Ratio formula

Figure 1 – Current ratio formula

The outcome of this ratio is often used to form an idea of the organization’s capital. It is about short-term obligations (liabilities) that can be repaid with short-term assets (cash, inventories, receivables).

Rule of Thumb : the higher this ratio is, the better the organization is able to repay their short-term liabilities.

If the outcome is lower than one, this indicates that the organization is unable to meet its short-term liabilities. This says something about the organization’s financial health, but that does not necessarily mean they are going bankrupt.

This ratio can say something about the efficiency of an organization with respect to turning over products into cash.

Liquidity problems may arise because of long-term outstanding debts, stock management or problems with the bank. A ratio of less than 1 indicates that an organization’s debts exceed its assets within a given period. That may seem like a problem, but sometimes there are various reasons for a negative ratio.

For example, a company’s cycle of collections and payment processes may cause the company to have a high ratio when receiving the payments, but a lower ratio when these collections and payments decrease. The ratio is therefore a snapshot, which may indicate that the company cannot cover all debts at that specific moment, but perhaps it can at a time when no customer payments are due.

The higher the ratio, the better the company is able to meet its obligations. A ratio that is too high, for example more than 3, can also indicate that the company cannot optimally use current assets, or that it cannot properly arrange financing.

A complete picture only emerges if the ratio is determined repeatedly over several periods.

Example of the course of the current ratio

We have seen that the ratio is not always a good representation of a company’s financial situation. What makes the ratio good or bad depends largely on how it progresses.

In other words: how the relationship between assets and liabilities changes. A company that seems to have a good ratio may evolve into a situation where it has the greatest possible difficulty in paying the bills. Conversely, a company with a lower ratio can take good steps towards a healthy ratio.

The trend of an ever-decreasing ratio can strongly influence a company’s valuation. A reverse trend may indicate the opportunity to invest in an undervalued stock during a switch.

Consider the example of two companies with a ratio of 1.00 today. Which company would analysts have a more optimistic outlook for?

Figure 2 – Current Ratio calculations

Figure 3 – Company A versus B, the financials

Two things stand out in the trend of Company A versus Company B. The trend for Company A is negative. That means doing further research is prudent. It could be that this company takes on more debt or that the cash balance becomes depleted. Both can pose a problem for solvency if the situation deteriorates.

The trend for company B is positive. This may indicate better collections, faster inventory turnover or that the company has been better able to pay off debt.

The second thing to note is that Company B’s ratio has been more volatile, with a big jump between the year 2020 and 2021. This may indicate increased risk and major pressure on the company’s value.

Limitations

One of the limitations of this ratio comes to the surface when the method is used to compare different companies. Companies differ considerably from each other, especially in different sectors. Comparing the ratios of these companies may not lead to any useful insight.

Now it’s your turn

What do you think? Is the Current Ratio still applicable in today’s modern economy and business world? Do you recognize the practical explanation or do you have more suggestions? What are your success factors for using financial ratios in relation of good business management?

Share your experience and knowledge in the comments box below.

More information

• Bates, T. W., Kahle, K. M., & Stulz, R. M. (2009). Why do US firms hold so much more cash than they used to? . The journal of finance, 64(5), 1985-2021.
• Berger, A. N., & Udell, G. F. (1995). Relationship lending and lines of credit in small firm finance . Journal of business, 351-381.
• Ross, S. A., Westerfield, R., & Jordan, B. D. (2008). Fundamentals of corporate finance . McGraw-Hill Education .

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Current Ratio- Formula, Interpretation & Example

If you wonder what is current ratio? How to calculate it? What is a good current ratio? And why good it is good for a company? Here we have addressed all these queries and tried to fade away all the question from your mind. Let’s begin with the definition.

In This Article

The current ratio of a company identifies the ability of a company to pay its short-term financial obligations. You can calculate it by simply dividing the current assets from its current liabilities.

Current Ratio = Current Assets / Current Liabilities

• A way of measuring company’s financial condition.
• Good ratio : CR >1
• Bad ratio : CR <1

Interpretation

Here, you are provided deeper understanding of what is it ? Current ratio of a company compares the current asset of a company to current liabilities. Similarly, to measure a company’s ability to pay its expenses or financial obligation we need to figure out company’s current ratio which in turn help us in figuring out the company’s financial condition.

What we need to know here is that if current ratio is greater than 1 it’s a good thing.

CR >1     where    CA> CL

This means current asset of the company exceeds current liabilities of the company. That’s a good thing for you, you have owe more than what you have to pay.

However, if current asset is less than 1 this means current asset is less than current liabilities.

CR<1    where     CA<CL

If the company’s liabilities exceeds its assets that is not a good sign but, if the company asset exceeds its liabilities that’s a good sign. So make sure your current liabilities don’t exceeds your current assets for the betterment of your company financial condition.

Moreover, you know, you can calculate working capital as well with the help of current assets and current liabilities just subtract current liabilities from current assets.

What is a Good Current Ratio?

When the current ratio is more than one it indicates a good ratio. The question may arise in your mind how it’s a good ratio? So, here we have elaborated all the quires to make things crystal clear. Just read ahead!

CURRENT ASSET > CURRENT LIABILITIES

A good current ratio is when the assets of a company exceed its liabilities. It is not difficult to understand why it is considered the best ratio because we have more assets than our liabilities. In other words, we owe more than what we have to pay. For instance, if you are running a business, the assets you have all together are worth $100 million but the liabilities you have to pay are $200 million. In this way, you have to pay more than what you have which is not a good sign for your company. Moreover, if you are running a business and the assets you have worth $400 million but the liabilities that you need to pay off our $200 million which is less than $400 million this is a good sign for your company because you don’t have to pay more than what you have.

In this way, if the current asset is less than 1 it is a bad sign. On the other hand, if the it is more than 1 it is a good sign.

Let’s talk about an example that is going to illustrate the current ratio. Here we’ll compare two companies. Ok, so let’s assume that company A has Six million dollars in currents assets. Furthermore, Company B also possess six million dollars in its current assets.  Company A has four million in current liabilities. However, company B has EIGHT million in currents liabilities. To calculate current ratio of a company we need to divide the current assets to liabilities of the respective company.

From this example we can clearly see that the current assets of company A exceeds the current liabilities. Company A has $600 million dollars in its assets which is greater than $400 million dollars. Likewise, we can see that the current ratio is above 1 which is a good sign for a company.

CA > CL           

On the other hand, if we take into account the current ratio of company B it is quite evident that the current liabilities of company B exceeds its assets. Company B has $600 million in its current assets while the current liabilities are $800 million. Therefore, we can see that the current ratio is below 1 which is not a good sign for a company. So, it is not a good thing to owe more than what you have.

CL> CA                          

Find it difficult to calculate current ratio? No worries! For your convenience, here is a free template for you to calculate current ratio where you have to only put values of current assets and current liabilities. Download your free current ratio excel template now.

Difference Between Quick Ratio and Current Ratio

Before rushing towards the difference between both here you are given a short explanation of what is quick ratio. Quick ratio in another liquidity ratio. Quick ratio also help us in measuring the financial ability of a company to pay its financial obligation.

The quick ratio is equal to liquid assets of a company minus inventory divided by current liabilities. The inventory is an asset but not a liquid asset, why? Because if the company has to sell the inventory quickly it may have to offer a discount. So, it takes more time to sell. Therefore, it is not a liquid asset.

Quick Ratio = Quick Assets / Current Liabilities

You can calculate quick ratio in two ways.

Let’s understand it with the help of example.

XYZ Company has $400 million in current asset, the inventory costs 50 million. While the liabilities which it need to pay off are $300 million.

Quick ratio = CA / CL

                     = (400 – 50)/300

                     = 350/300

                     = 1.16

So, the quick ratio here is above 1 which is a good sign for the company. As you want the current assets to exceed the current liabilities. That means the company can easily pay off its financial obligation through its current assets.

Quick Ratio vs Current Ratio

Let’s have a look at the difference between quick ratio vs current ratio. We can easily distinguish between two by looking at their formula.

In current ratio, we divide current assets by current liabilities. To calculate current assets you should add all those asset that can easily be convertible into cash within one year period. It includes cash & cash equivalent, accounts receivable, inventory, prepaid expenses, and other current assets. Moreover, current liabilities are also those liabilities that are payable within one year. Thus, it includes accounts payable, notes payable, and accrued liabilities.

While in quick ratio, we need to minus the inventory and prepaid expenses from the current assets and then we divide it by current liabilities. Quick assets are those assets that are readily convertible into cash within one or two months. Quick assets includes cash and cash equivalent, accounts receivable and marketable securities.

• The current ratio of a company identifies the ability of a company to pay its short-term financial obligations.
• To calculate, just divide current assets from its current liabilities. 
• When it is more than one it` indicates a good ratio.

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Financial Ratio Analysis Tutorial With Examples

The Balance Sheet for Financial Ratio Analysis

The income statement for financial ratio analysis, analyzing the liquidity ratios, the current ratio, the quick ratio, analyzing the asset management ratios accounts receivable, receivables turnover, average collection period, inventory, fixed assets, total assets, inventory turnover ratio, fixed asset turnover, total asset turnover, analyzing the debt management ratios, debt-to-asset ratio, times interest earned ratio, fixed charge coverage, analyzing the profitability ratios, net profit margin, return on assets, return on equity, financial ratio analysis of xyz corporation.

While it may be more fun to work on marketing efforts, the financial management of a firm is a crucial aspect of owning a business. Financial ratios help break down complex financial information into key details and relationships. Financial ratio analysis involves studying these ratios to learn about the company's financial health.

Here are a few of the most important financial ratios for business owners to learn, what they tell you about the company's financial statements, and how to use them.

Key Takeaways

• Some of the most important financial ratios for business owners include the current ratio, the inventory turnover ratio, and the debt-to-asset ratio.
• These financial ratios quickly break down the complex information from financial statements .
• Financial ratios are snapshots, so it's important to compare the information to previous periods of data as well as competitors in the industry.

Here is the balance sheet we are going to use for our financial ratio tutorial. You will notice there are two years of data for this company so we can do a time-series (or trend) analysis and see how the firm is doing across time.

Here is the complete income statement for the firm for which we are doing financial ratio analysis. We are doing two years of financial ratio analysis for the firm so we can compare them.

Refer back to the income statement and balance sheet as you work through the tutorial.

The first ratios to use to start getting a financial picture of your firm measure your liquidity, or your ability to convert your current assets to cash quickly. They are two of the 13 ratios. Let's look at the current ratio and the quick (acid-test) ratio .

The current ratio measures how many times you can cover your current liabilities. The quick ratio measures how many times you can cover your current liabilities without selling any inventory and so is a more stringent measure of liquidity.

Remember that we are doing a time series analysis, so we will be calculating the ratios for each year.

Current Ratio : For 2022, take the Total Current Assets and divide them by the Total Current Liabilities. You will have: Current Ratio = 642/543 = 1.18X. This means that the company can pay for its current liabilities 1.18 times over. Practice calculating the current ratio for 2023.

Your answer for 2023 should be 1.31X. A quick analysis of the current ratio will tell you that the company's liquidity has gotten just a little bit better between 2022 and 2023 since it rose from 1.18X to 1.31X.

Quick Ratio : In order to calculate the quick ratio, take the Total Current Ratio for 2022 and subtract out Inventory. Divide the result by Total Current Liabilities. You will have: Quick Ratio = (642-393)/543 = 0.46X. For 2023, the answer is 0.52X.

Like the current ratio, the quick ratio is rising and is a little better in 2023 than in 2022. The firm's liquidity is getting a little better. The problem for this company, however, is that they have to sell inventory to pay their short-term liabilities and that is not a good position for any firm to be in. This is true in both 2022 and 2023.

This firm has two sources of current liabilities: accounts payable and notes payable. They have bills that they owe to their suppliers (accounts payable) plus they apparently have a bank loan or a loan from some alternative source of financing. We don't know how often they have to make a payment on the note.

Asset management ratios are the next group of financial ratios that should be analyzed. They tell the business owner how efficiently they employ their assets to generate sales. Assume all sales are on credit.

• Receivables Turnover = Credit Sales/Accounts Receivable
• Receivables Turnover = 2,311/165 = 14X

A receivables turnover of 14X in 2022 means that all accounts receivable are cleaned up (paid off) 14 times during the 2022 year. For 2023, the receivables turnover is 15.28X. Look at 2022 and 2023 Sales in The Income Statement and Accounts Receivable in The Balance Sheet.

The receivables turnover is rising from 2022 to 2023. We can't tell if this is good or bad. We would really need to know what type of industry this firm is in and get some industry data to compare to.

Customers paying off receivables is, of course, good. But, if the receivables turnover is way above the industry's, then the firm's credit policy may be too restrictive.

The average collection period is also about accounts receivable. It is the number of days, on average, that it takes a firm's customers to pay their credit accounts. Together with receivables turnover, the average collection helps the firm develop its credit and collections policy.

• Average Collection Period = Accounts Receivable/Average Daily Credit Sales
• To arrive at average daily credit sales, take credit sales and divide by 360
• Average Collection Period = $165/2,311/360 = $165/6.42 = 25.7 days
• In 2023, the average collection period is 23.5 days

From 2022 to 2023, the average collection period is dropping. In other words, customers are paying their bills more quickly. Compare that to the receivables turnover ratio. Receivables turnover is rising and the average collection period is falling.

This makes sense because customers are paying their bills faster. The company needs to compare these two ratios to industry averages. In addition, the company should take a look at its credit and collections policies to be sure they are not too restrictive. Take a look at the image above and you can see where the numbers came from on the balance sheets and income statements.

Along with the accounts receivable ratios that we analyzed above, we also have to analyze how efficiently we generate sales with our other assets: inventory, plant and equipment, and our total asset base.

The inventory turnover ratio is one of the most important ratios a business owner can calculate and analyze. If your business sells products as opposed to services, then inventory is an important part of your equation for success.

Inventory Turnover = Sales/Inventory

If your inventory turnover is rising, that means you are selling your products faster. If it is falling, you are in danger of holding obsolete inventory. A business owner has to find the optimal inventory turnover ratio where the ratio is not too high and there are no stockouts or too low where there is obsolete money. Both are costly to the firm.

For this company, their inventory turnover ratio for 2022 is:

Inventory Turnover Ratio = Sales/Inventory = 2,311/393 = 5.9X

This means that this company completely sells and replaces its inventory 5.9 times every year. In 2023, the inventory turnover ratio is 6.8X. The firm's inventory turnover is rising. This is good in that they are selling more products. The business owner should compare the inventory turnover with the inventory turnover ratio of other firms in the same industry.

The fixed asset turnover ratio analyzes how well a business uses its plant and equipment to generate sales. A business firm does not want to have either too little or too much plant and equipment. For this firm for 2022:

Fixed Asset Turnover = Sales/Fixed Assets = 2,311/2,731 = 0.85X

For 2023, the fixed asset turnover is 1.00. The fixed asset turnover ratio is dragging down this company. They are not using their plant and equipment efficiently to generate sales as, in both years, fixed asset turnover is very low.

The total asset turnover ratio sums up all the other asset management ratios. If there are problems with any of the other total assets, it will show up here, in the total asset turnover ratio.

Total Asset Turnover = Sales/Total Asset Turnover = Sales/Total Assets = 2,311/3,373 = 0.69X for 2022. For 2023, the total asset turnover is 0.80. The total asset turnover ratio is somewhat concerning since it was not even 1X for either year.

This means that it was not very efficient. In other words, the total asset base was not very efficient in generating sales for this firm in 2022 or 2023. Why?

It seems that most of the problem lies in the firm's fixed assets. They have too much plant and equipment for their level of sales. They either need to find a way to increase their sales or sell off some of their plant and equipment. The fixed asset turnover ratio is dragging down the total asset turnover ratio and the firm's asset management in general.

There are three debt management ratios that help a business owner evaluate the company in light of its asset base and earning power. Those ratios are the debt-to-asset ratio, the times interest earned ratio , and the fixed charge coverage ratios. Other debt management ratios exist, but these help give business owners the first look at the debt position of the company and the prudence of that debt position.

The first debt ratio that is important for the business owner to understand is the debt-to-asset ratio ; in other words, how much of the total asset base of the firm is financed using debt financing. For example. the debt-to-asset ratio for 2022 is:

Total Liabilities/Total Assets = $1,074/3,373 = 31.8%. This means that 31.8% of the firm's assets are financed with debt. In 2023, the debt ratio is 27.8%. In 2023, the business is using more equity financing than debt financing to operate the company.

We don't know if this is good or bad since we do not know the debt-to-asset ratio for firms in this company's industry. However, we do know that the company has a problem with its fixed asset ratio which may be affecting the debt-to-asset ratio.

The times interest earned ratio tells a company how many times over a firm can pay the interest that it owes. Usually, the more times a firm can pay its interest expense the better. The times interest earned ratio for this firm for 2022 is:

• Times Interest Earned = Earnings Before Interest and Taxes/Interest = 276/141 = 1.96X
• For 2023, the times interest earned ratio is 3.35

The times interest earned ratio is very low in 2022 but better in 2023. This is because the debt-to-asset ratio dropped in 2023.

The fixed charge coverage ratio is very helpful for any company that has any fixed expenses they have to pay. One fixed charge (expense) is interest payments on debt, but that is covered by the times interest earned ratio.

Another fixed charge would be lease payments if the company leases any equipment, a building, land, or anything of that nature. Larger companies have other fixed charges which can be taken into account.

• Fixed charge coverage = Earnings Before Fixed Charges and Taxes/Fixed Charges

In both 2022 and 2023 for the company in our example, its only fixed charge is interest payments. So, the fixed charge coverage ratio and the times interest earned ratio would be exactly the same for each year for each ratio.

The last group of financial ratios that business owners usually tackle are the profitability ratios as they are the summary ratios of the 13 ratio group. They tell the business firm how they are doing on cost control, efficient use of assets, and debt management, which are three crucial areas of the business.

The net profit margin measures how much each dollar of sales contributes to profit and how much is used to pay expenses. For example, if a company has a net profit margin of 5%, this means that 5 cents of every sales dollar it takes in goes to profit and 95 cents goes to expenses. For 2022, here is XYZ, Inc.'s net profit margin:

Net Profit Margin = Net Income/Sales Revenue = 89.1/2,311 = 3.9%

For 2023, the net profit margin is 6.5%, so there was quite an increase in their net profit margin. You can see that their sales took quite a jump but their cost of goods sold rose. It is the best of both worlds when sales rise and costs fall. Bear in mind: The company can still have problems even if this is the case.

The return on assets ratio, also called return on investment , relates to the firm's asset base and what kind of return they are getting on their investment in their assets. Look at the total asset turnover ratio and the return on asset ratio together. If total asset turnover is low, the return on assets is going to be low because the company is not efficiently using its assets.

Another way to look at the return on assets is in the context of the Dupont method of financial analysis. This method of analysis shows you how to look at the return on assets in the context of both the net profit margin and the total asset turnover ratio.

• To calculate the Return on Assets ratio for XYZ, Inc. for 2022, here's the formula:
• Return on Assets = Net Income/Total Assets = 2.6%

For 2023, the ROA is 5.2%. The increased return on assets in 2023 reflects the increased sales and much higher net income for that year.

The return on equity ratio is the one of most interest to the shareholders or investors in the firm. This ratio tells the business owner and the investors how much income per dollar of their investment the business is earning. This ratio can also be analyzed by using the Dupont method of financial ratio analysis. The company's return on equity for 2022 was:

Return on Equity = Net Income/Shareholder's Equity = 3.9%

For 2023, the return on equity was 7.2%. One reason for the increased return on equity was the increase in net income. When analyzing the return on equity ratio, the business owner also has to take into consideration how much of the firm is financed using debt and how much of the firm is financed using equity.

Now we have a summary of all 13 financial ratios for XYZ Corporation. The first thing that jumps out is the low liquidity of the company. We can look at the current and quick ratios for 2022 and 2023 and see that the liquidity is slightly increasing between 2022 and 2023, but it is still very low.

By looking at the quick ratio for both years, we can see that this company has to sell inventory in order to pay off short-term debt. The company does have short-term debt: accounts payable and notes payable, and we don't know when the notes payable will come due.

Let's move on to the asset management ratios. We can see that the firm's credit and collections policies might be a little restrictive by looking at the high receivable turnover and low average collection period. Customers must pay this company rapidly—perhaps too rapidly. There is nothing particularly remarkable about the inventory turnover ratio, but the fixed asset turnover ratio is remarkable.

The fixed asset turnover ratio measures the company's ability to generate sales from its fixed assets or plant and equipment. This ratio is very low for both 2022 and 2023. This means that XYZ has a lot of plant and equipment that is unproductive.

It is not being used efficiently to generate sales for the company. In addition, the company has to service the plant and equipment, pay for breakdowns, and perhaps pay interest on loans to buy it through long-term debt.

It seems that a very low fixed asset turnover ratio might be a major source of problems for XYZ. The company should sell some of this unproductive plant and equipment, keeping only what is absolutely necessary to produce their product.

The low fixed asset turnover ratio is dragging down total asset turnover. If you follow this analysis through, you will see that it is also substantially lowering this firm's return on assets profitability ratio.

With this firm, it is hard to analyze the company's debt management ratios without industry data. We don't know if XYZ is a manufacturing firm or a different type of firm.

As a result, analyzing the debt-to-asset ratio is difficult. What we can see, however, is that the company is financed more with shareholder funds (equity) than it is with debt as the debt-to-asset ratio for both years is under 50% and dropping.

This fact means that the return on equity profitability ratio will be lower than if the firm was financed more with debt than with equity. On the other hand, the risk of bankruptcy will also be lower.

Unfortunately, you can see from the times interest earned ratio that the company does not have enough liquidity to be comfortable servicing its debt. The company's costs are high and liquidity is low. Fortunately, the company's net profit margin is increasing because their sales are increasing.

Hopefully, this is a trend that will continue. Return on Assets is impacted negatively due to the low fixed asset turnover ratio and, to some extent, by the receivables ratios. Return on equity is increasing from 2022 to 2023, which will make investors happy.

As you can see, it is possible to do a cursory financial ratio analysis of a business firm with only 13 financial ratios, even though ratio analysis has inherent limitations.

Julie Dahlquist, Rainford Knight. " Principles of Finance: 6.2 Operating Efficiency Ratios ." OpenStax.

U.S. Small Business Administration. " Calculate & Analyze Your Financial Ratios ," Pages 2, 4.

U.S. Small Business Administration. " Calculate & Analyze Your Financial Ratios ," Pages 3, 6.

Julie Dahlquist, Rainford Knight. " Principles of Finance: 6.4 Solvency Ratios ." OpenStax.

Nasdaq. " Fixed-Charge Coverage Ratio ."

U.S. Small Business Administration. " Calculate & Analyze Your Financial Ratios ," Pages 3, 5.

Julie Dahlquist, Rainford Knight. " Principles of Finance: 6.6 Profitability Ratios and the DuPont Method ." OpenStax.

Ratio Analysis: Problems and Solutions | Accounting

Here is a compilation of top thirteen accounting problems on ratio analysis with its relevant solutions.

The following is the Balance Sheet of a company as on 31st March:

How to Analyze and Improve Current Ratio?

• Why is Improvement in Current Ratio Important?

The current ratio is a critical liquidity ratio utilized extensively by banks and other financing institutions while extending loans to businesses. “How to improve the current ratio?” is a general question that keeps hitting the entrepreneur’s mind now and then. For improving the current ratio, the management needs to focus on various strategies, including its current liabilities and assets, which are not one-time activities. The company has to monitor it throughout the year.

Current Ratio in Brief

The current ratio is a figure that results from dividing current assets by the current liabilities. This figure is important because it measures the liquidity stand of a firm. Normally, the assumption is that the higher the ratio, the higher is the liquidity, and vice versa. It would be unfair to conclude the liquidity based on the ratio. Without further knowing what makes this ratio, it isn’t easy to form an opinion. We can understand it better with the help of the following situation:

Explanation

Faster conversion cycle of debtors or accounts receivables, pay off current liabilities, sell-off unproductive assets.

• Improve Current Assets by Rising Shareholder’s Funds

Sweep Bank Accounts

• Normally, a dipping sale would increase the level of inventories. We cannot settle the claims of creditors with inventory; it would require hard cash. Undoubtedly, the ratio, in this case, is increasing but without improving the liquidity.
• Secondly, delayed payments by customers will increase the debtor’s level and eventually the current assets and, therefore, the current ratio. Here also, we can see the increase in the current ratio but a decline in the actual level of liquidity.

With the help of the above example, let us understand better, a current ratio of 1:1 is not sufficient because all the current assets are not readily convertible into cash. There is always a requirement for a cushion over and above 1. This cushion is technically called “Margin of Safety.” In other words, current assets over and above the current liabilities are the margin of safety. We need marginal current assets simply as all the current assets can quickly liquidate to cash.

Refer to CURRENT RATIO for details.

How to Improve the Current Ratio?

Faster rolling of money via debtors will keep the current ratio in control. At least, the ratio will show the correct picture if the debtors are liquid. A constant follow-up with the debtors can improve the collections from them. The payment terms should be clear in the first dealing itself, and the negotiated credit period should be as low as possible.

Also Read: How to Reduce Current Ratio and Why?

Not only does the current ratio depend on current assets, but it is also equally dependent on the current liability, which is the denominator. They should pay off as often and as early as possible. It would decrease the level of current liabilities and, therefore, improve the current ratio. Early payments to creditors can save interest costs and earn discounts, directly impacting the firm’s profits.

The cash level can also increase by selling unused fixed assets. Otherwise, the money unnecessarily gets blocked into them, and idle cash accrues interest costs.

Improve Current Assets by Rising Shareholder’s Funds

When the current assets are financed by equity rather than the creditors, the level of current assets will increase with current liabilities remaining the same. Consequently, this exercise will improve the current ratio. Considering the improvement of the current ratio, drawings are not advisable. It is because drawings would reduce capital investment in the current assets. And therefore, the level of current liabilities will increase to finance the current asset. All this directly impacts the current ratio. In essence, owners’ funds, i.e., capital and reserves, and surpluses should remain invested in the firm to balance the current ratio.

First of all, the firm’s management should always try to cut down on challenging cash levels and keep the money in bank accounts. The sweeping facility should be available in the bank accounts, which almost every bank and financial institution provide. Sweeping is a facility by which the excess funds from the current account are transferred to another account that fetches interest on that fund. At the same time, these funds are available to use when required.

Also Read: Current Ratio – Meaning, Formula, Calculation, and Interpretation

Our conversation above is mainly focusing on analyzing and improving the current ratio. Normally, the rule for this ratio is “higher the better.” It would be pretty interesting to know that in certain situations, it is advisable to reduce the current ratio.

Let’s check out  Why and How to Reduce Current Ratio?

Quiz on How to Analyze and Improve Current Ratio?

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RELATED POSTS

• Advantages and Disadvantages of Current Ratio
• How to Improve Liquidity by Effective Cash Management?
• How to Analyze (Interpret) and Improve Quick Ratio?
• Importance of Working Capital Management
• Liquidity Ratios
• Factors Affecting Liquidity of Accounts Receivable

Sanjay Bulaki Borad

MBA-Finance, CMA, CS, Insolvency Professional, B'Com

Sanjay Borad, Founder of eFinanceManagement, is a Management Consultant with 7 years of MNC experience and 11 years in Consultancy. He caters to clients with turnovers from 200 Million to 12,000 Million, including listed entities, and has vast industry experience in over 20 sectors. Additionally, he serves as a visiting faculty for Finance and Costing in MBA Colleges and CA, CMA Coaching Classes.

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How to Calculate the Current Ratio in Excel

The current ratio is a metric used by the finance industry to assess a company's short-term liquidity . It reflects a company's ability to generate enough cash to pay off all debts should they become due at the same time. While this scenario is highly unlikely, the ability of a business to liquidate assets quickly to meet obligations is indicative of its overall financial health.

Determining the Current Ratio

The current ratio, also known as a liquidity ratio, is a simple concept that requires only two pieces of data to compute: the total current assets and the total current liabilities .

Current assets include only those assets that take the form of cash or cash equivalents , such as stocks or other marketable securities that can be liquidated quickly. Current liabilities consist of only those debts that become due within the next year. By dividing the current assets by the current liabilities, the current ratio reflects the degree to which a company's short-term resources outstrip its debts.

Ideally, a company having a current ratio of 2 would indicate that its assets equal twice its liabilities. While lower ratios may indicate a reduced ability to meet obligations, there are no hard and fast rules when it comes to a good or bad current ratio. Each company's ratio should be compared to those of others in the same industry, and with similar business models to establish what level of liquidity is the industry standard.

Calculating the Current Ratio in Excel

For very small businesses, calculating total current assets and total current liabilities may not be an overwhelming endeavor. As businesses grow, however, the number and types of debts and income streams can become greatly diversified. Microsoft Excel provides numerous free accounting templates that help to keep track of cash flow and other profitability metrics, including the liquidity analysis and ratios template.

Once you have determined your asset and liability totals, calculating the current ratio in Excel is very straightforward, even without a template.

First, input your current assets and current liabilities into adjacent cells, say B3 and B4. In cell B5, input the formula "=B3/B4" to divide your assets by your liabilities, and the calculation for the current ratio will be displayed.

As an example, let's say that a small business owner named Frank is looking to expand and needs to determine his ability to take on more debt. Before applying for a loan, Frank wants to be sure he is more than able to meet his current obligations. Frank also wants to see how much new debt he can take on without overstretching his ability to cover payments. He doesn't want to rely on additional income that may or may not be generated by the expansion, so it's important to be sure his current assets can handle the increased burden.

After consulting the  income statement , Frank determines that his current assets for the year are $150,000, and his current liabilities clock in at $60,000. By dividing the assets of the business by its liabilities, a current ratio of 2.5 is calculated. Since the business has such an excellent ratio already, Frank can take on at least an additional $15,000 in loans to fund the expansion without sacrificing liquidity.

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Current Formula

The current formula is derived from Ohm's law. Current is defined as the flow of electrons in an electric circuit. The flow of electrons occurs due to potential differences. The current is also known as the rate of change of charge with time. Current is represented by I and SI unit of current is Ampere. Let us learn the application of the electric current formula in the section below.

What Is the Current Formula?

Ohm's Law states that the voltage (V) across a conductor is equal to the product of the current (I) flowing through it and the resistance (R) of the conductor. According to Ohm's law, the current is the ratio of the potential difference (voltage) and the resistance. Thus, the electric current formula is given by: I = V/R

• I represent current in Ampere (A),
• V is the potential difference in Volt (V)
• R is the resistance in Ohm (Ω).

This current equation can be used to calculate the current in a circuit if the voltage and resistance are known, or to calculate the current or resistance if the other two values are known.

Let us see the applications of the current formula in the following solved examples section.

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Examples Using Current Formula

Example 1: In an electric circuit, the potential difference and the resistance are given as 20V and 4Ω respectively. Calculate current flowing in the circuit.

To find: Current (I) flowing in the circuit.

V = 20 V, R = 4 Ω

Using current equation,

Answer: Current flowing in the circuit is 5 Ampere.

Example 2: The total current flowing in an electric circuit is 50 Amp whereas the resistance of the wires is 14 Ohm. Find the potential difference.

To find the potential difference:

I = 50 A, R = 14 Ω

Using electric current formula

V = 50 × 14

Answer: Potential difference is 700 V.

Example 3: In an electric circuit, the potential difference is 20 V and the value of current is 5 Amp respectively. Using the current formula, find the resistance of the circuit.

To find the resistance (R) of the circuit:

V = 20 V, I = 5 Amp

Using current formula

Answer: The resistance of the circuit 4 Ω.

FAQs on Current Formula

How do you calculate current using current formula.

If the voltage (V) and resistance (R) of any circuit is given we can use the electric current formula to calculate the current, i.e., I = V/R (amps).

How Do You Calculate Voltage Using Current Formula?

If the current (I) and resistance (R) of any circuit is given we can mold the current formula to calculate the voltage, i.e., V = IR (Volts).

Can the Current Formula be Used for Both DC and AC Circuits?

The current equation (I = V/R) is used for both direct current (DC) and alternating current (AC) circuits. However, it's important to note that for AC circuits, the resistance (R) is often replaced by impedance (Z) since AC circuits involve the effects of both reactance and resistance.

How Do You Calculate Resistance Using the Current Formula?

If the current (I) and potential difference (V) of any circuit are given we can mould the current formula to calculate the resistance, i.e., R = V/I (Ohms Ω).

What Is the Definition of Electric Current Formula? Write Its SI Unit.

The current is the ratio of the potential difference and the resistance. It is represented as (I). The current formula is given as I = V/R. The SI unit of current is Ampere (Amp).

What Happens if the Resistance is Zero in the Current Formula?

The current equation is I = V/R. If the resistance, R = 0, I = V/R would result in an undefined value for current (I/0). In practical terms, it means when an extremely high current can flow, potentially causing damage to the circuit or equipment, i.e., it would imply a short circuit.

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Ratio problem solving

Here you will learn about ratio problem solving, including how to set up and solve problems. You will also look at real life ratio word problems.

Students will first learn about ratio problem solving as part of ratio and proportion in 6 th grade and 7 th grade.

What is ratio problem solving?

Ratio problem solving is a collection of ratio and proportion word problems that link together aspects of ratio and proportion into more real life questions. This requires you to be able to take key information from a question and use your knowledge of ratios (and other areas of the curriculum) to solve the problem.

A ratio is a relationship between two or more quantities. They are usually written in the form a : b where a and b are two quantities. When problem solving with a ratio, the key facts that you need to know are:

• What is the ratio involved?
• What order are the quantities in the ratio?
• What is the total amount / what is the part of the total amount known?
• What are you trying to calculate ?

As with all problem solving, there is not one unique method to solve a problem. However, this does not mean that there aren’t similarities between different problems that you can use to help you find an answer.

The key to any problem solving is being able to draw from prior knowledge and use the correct piece of information to allow you to get to the next step and then the solution.

Let’s look at a couple of methods you can use when given certain pieces of information.

When solving ratio word problems, it is very important that you are able to use ratios. This includes being able to use ratio notation.

For example, Charlie and David share some sweets in the ratio of 3 : 5. This means that for every 3 sweets Charlie gets, David receives 5 sweets.

Charlie and David share 40 sweets, how many sweets do they each get?

You use the ratio to divide 40 sweets into 8 equal parts.

40 \div 8=5

Then you multiply each part of the ratio by 5.

3\times 5:5\times 5=15 : 25

This means that Charlie will get 15 sweets and David will get 25 sweets.

There can be ratio word problems involving different operations and types of numbers.

Here are some examples of different types of ratio word problems:

Common Core State Standards

How does this relate to 6 th and 7 th grade math?

• Grade 6 – Ratios and Proportional Relationships (6.RP.A.3) Use ratio and rate reasoning to solve real-world and mathematical problems, for example, by reasoning about tables of equivalent ratios, tape diagrams, double number line diagrams, or equations.
• Grade 7 – Ratio and Proportional Relationships (7.RP.A.2) Recognize and represent proportional relationships between quantities.

How to do ratio problem solving

In order to solve problems including ratios:

Identify key information within the question.

Know what you are trying to calculate.

Use prior knowledge to structure a solution.

[FREE] Ratio Problem Solving Worksheet (Grade 6 to 8)

Use this worksheet to check your grade 6 to 8 students’ understanding of ratio problem solving. 15 questions with answers to identify areas of strength and support!

Ratio problem solving examples

Example 1: part:part ratio.

Within a school, the total number of students who have school lunches to packed lunches is 5 : 7. If 465 students have a school lunch, how many students have a packed lunch?

Within a school, the number of students who have school lunches to packed lunches is \textbf{5 : 7} . If \textbf{465} students have a school lunch, how many students have a packed lunch?

Here you can see that the ratio is 5 : 7, where the first part of the ratio represents school lunches (S) and the second part of the ratio represents packed lunches (P).

You could write this as:

Where the letter above each part of the ratio links to the question.

You know that 465 students have school lunch.

2 Know what you are trying to calculate.

From the question, you need to calculate the number of students that have a packed lunch, so you can now write a ratio below the ratio 5 : 7 that shows that you have 465 students who have school lunches, and p students who have a packed lunch.

You need to find the value of p.

3 Use prior knowledge to structure a solution.

You are looking for an equivalent ratio to 5 : 7. So you need to calculate the multiplier.

You do this by dividing the known values on the same side of the ratio by each other.

465\div 5 = 93

This means to create an equivalent ratio, you can multiply both sides by 93.

So the value of p is equal to 7 \times 93=651.

There are 651 students that have a packed lunch.

Example 2: unit conversions

The table below shows the currency conversions on one day.

Use the table above to convert £520 \; (GBP) to Euros € \; (EUR).

Use the table above to convert \bf{￡520} \textbf{ (GBP)} to Euros \textbf{€ } \textbf{(EUR)}.

The two values in the table that are important are \text{GBP} and EUR. Writing this as a ratio, you can state,

You know that you have £520.

You need to convert GBP to EUR and so you are looking for an equivalent ratio with GBP=£520 and EUR=E.

To get from 1 to 520, you multiply by 520 and so to calculate the number of Euros for £520, you need to multiply 1.17 by 520.

1.17 \times 520=608.4

So £520=€608.40.

Example 3: writing a ratio 1 : n

Liquid plant food is sold in concentrated bottles. The instructions on the bottle state that the 500 \, ml of concentrated plant food must be diluted into 2 \, l of water. Express the ratio of plant food to water, respectively, in the ratio 1 : n.

Liquid plant food is sold in concentrated bottles. The instructions on the bottle state that the \bf{500 \, ml} of concentrated plant food must be diluted into \bf{2 \, l} of water. Express the ratio of plant food to water respectively as a ratio in the form 1 : n.

Using the information in the question, you can now state the ratio of plant food to water as 500 \, ml : 2 \, l. As you can convert liters into milliliters, you could convert 2 \, l into milliliters by multiplying it by 1000.

2 \, l=2000 \, ml

So you can also express the ratio as 500 : 2000 which will help you in later steps.

You want to simplify the ratio 500 : 2000 into the form 1:n.

You need to find an equivalent ratio where the first part of the ratio is equal to 1. You can only do this by dividing both parts of the ratio by 500 (as 500 \div 500=1 ).

So the ratio of plant food to water in the form 1 : n is 1 : 4.

Example 4: forming and solving an equation

Three siblings, Josh, Kieran and Luke, receive an allowance each week proportional to their age. Kieran is 3 years older than Josh. Luke is twice Josh’s age. If Josh receives \$ 8 allowance, how much money do the three siblings receive in total?

Three siblings, Josh, Kieran and Luke, receive an allowance each week proportional to their ages. Kieran is \bf{3} years older than Josh. Luke is twice Josh’s age. If Luke receives \bf{\$ 8} allowance, how much money do the three siblings receive in total?

You can represent the ages of the three siblings as a ratio. Taking Josh as x years old, Kieran would therefore be x+3 years old, and Luke would be 2x years old. As a ratio, you have:

You also know that Luke receives \$ 8.

You want to calculate the total amount of allowance for the three siblings.

You need to find the value of x first. As Luke receives \$ 8, you can state the equation 2x=8 and so x=4.

Now you know the value of x, you can substitute this value into the other parts of the ratio to obtain how much money the siblings each receive.

The total amount of allowance is therefore 4+7+8=\$ 19.

Example 5: simplifying ratios

Below is a bar chart showing the results for the colors of counters in a bag.

Express this data as a ratio in its simplest form.

From the bar chart, you can read the frequencies to create the ratio.

You need to simplify this ratio.

To simplify a ratio, you need to find the highest common factor of all the parts of the ratio. By listing the factors of each number, you can quickly see that the highest common factor is 2.

\begin{aligned} & 12 = 1, {\color{red}2}, 3, 4, 6, 12 \\\\ & 16 = 1, {\color{red}2}, 4, 8, 16 \\\\ & 10 = 1, {\color{red}2}, 5, 10 \end{aligned}

HCF(12,16,10) = 2

Dividing all the parts of the ratio by 2, you get

Our solution is 6 : 8 : 5.

Example 6: combining two ratios

Glass is made from silica, lime and soda. The ratio of silica to lime is 15 : 2. The ratio of silica to soda is 5 : 1. State the ratio of silica:lime:soda.

Glass is made from silica, lime and soda. The ratio of silica to lime is \bf{15 : 2}. The ratio of silica to soda is \bf{5 : 1}. State the ratio of silica:lime:soda.

You know the two ratios

You are trying to find the ratio of all 3 components: silica, lime and soda.

Using equivalent ratios you can say that the ratio of Silica:Soda is equivalent to 15 : 3 by multiplying the ratio by 3.

You now have the same amount of silica in both ratios and so you can now combine them to get the ratio 15 : 2 : 3.

Example 7: using bar modeling

India and Beau share some popcorn in the ratio of 5 : 2. If India has 75 \, g more popcorn than Beau, what was the original quantity?

India and Beau share some popcorn in the ratio of \bf{5 : 2} . If India has \bf{75 \, g} more popcorn than Beau, what was the original quantity?

You know that the initial ratio is 5 : 2 and that India has three more parts than Beau.

You want to find the original quantity.

Drawing a bar model of this problem, you have:

Where India has 5 equal shares, and Beau has 2 equal shares.

Each share is the same value and so if you can find out this value, you can then find the total quantity.

From the question, India’s share is 75 \, g more than Beau’s share so you can write this on the bar model.

You can find the value of one share by working out 75 \div 3=25 \, g.

You can fill in each share to be 25 \, g.

Adding up each share, you get

India=5 \times 25=125 \, g

Beau=2 \times 25=50 \, g

The total amount of popcorn was 125+50=175 \, g.

Teaching tips for ratio problem solving

• Continue to remind students that when solving ratio word problems, it’s important to identify the quantities being compared and express the ratio in its simplest form.
• Create practice problems for students using the information in your classroom. For example, ask students to find the ratio of boys to the ratio of girls using the total number of students in your classroom, then the school.
• To find more practice questions, utilize educational websites and apps instead of worksheets. Some of these may also provide tutorials for struggling students. These can also be helpful for test prep as they are more engaging for students.
• Use a variety of numbers in your ratio word problems – whole numbers, fractions, decimals, and mixed numbers – to give students a variety of practice.
• Provide students with a step-by-step process for problem solving, like the one shown above, that can be applied to every ratio word problem.

Easy mistakes to make

• Mixing units Make sure that all the units in the ratio are the same. For example, in example 6, all the units in the ratio were in milliliters. You did not mix ml and l in the ratio.
• Writing ratios in the wrong order For example, the number of dogs to cats is given as the ratio 12 : 13 but the solution is written as 13 : 12.

• Counting the number of parts in the ratio, not the total number of shares For example, the ratio 5 : 4 has 9 shares, and 2 parts. This is because the ratio contains 2 numbers but the sum of these parts (the number of shares) is 5+4=9. You need to find the value per share, so you need to use the 9 shares in your next line of working.
• Ratios of the form \bf{1 : \textbf{n}} The assumption can be incorrectly made that n must be greater than 1, but n can be any number, including a decimal.

Related ratio lessons

• Unit rate math
• Simplifying ratios
• Ratio to fraction
• How to calculate exchange rates
• Ratio to percent
• How to write a ratio
• Dividing ratios
• How to find the unit rate
• Ratio scale
• Constant of proportionality

Practice ratio problem solving questions

1. An online shop sells board games and computer games. The ratio of board games to the total number of games sold in one month is 3 : 8. What is the ratio of board games to computer games?

8-3=5 computer games sold for every 3 board games.

2. The ratio of prime numbers to non-prime numbers from 1-200 is 45 : 155. Express this as a ratio in the form 1 : n.

You need to simplify the ratio so that the first number is 1. That means you need to divide each number in the ratio by 45.

45 \div 45=1

155\div{45}=3\cfrac{4}{9}

3. During one month, the weather was recorded into 3 categories: sunshine, cloud and rain. The ratio of sunshine to cloud was 2 : 3 and the ratio of cloud to rain was 9 : 11. State the ratio that compares sunshine:cloud:rain for the month.

3 \times S : C=6 : 9

4. The angles in a triangle are written as the ratio x : 2x : 3x. Calculate the size of each angle.

You should know that the 3 angles in a triangle always equal 180^{\circ}.

\begin{aligned} & x+2 x+3 x=180 \\\\ & 6 x=180 \\\\ & x=30^{\circ} \\\\ & 2 x=60^{\circ} \\\\ & 3 x=90^{\circ} \end{aligned}

5. A clothing company has a sale on tops, dresses and shoes. \cfrac{1}{3} of sales were for tops, \cfrac{1}{5} of sales were for dresses, and the rest were for shoes. Write a ratio of tops to dresses to shoes sold in its simplest form.

\cfrac{1}{3}+\cfrac{1}{5}=\cfrac{5+3}{15}=\cfrac{8}{15}

1-\cfrac{8}{15}=\cfrac{7}{15}

6. The volume of gas is directly proportional to the temperature (in degrees Kelvin). A balloon contains 2.75 \, l of gas and has a temperature of 18^{\circ}K. What is the volume of gas if the temperature increases to 45^{\circ}K?

The given ratio in the word problem is 2. 75 \mathrm{~L}: 18^{\circ} \mathrm{K}

Divide 45 by 18 to see the relationship between the two temperatures.

45 \div 18=2.5

45 is 2.5 times greater than 18. So we multiply 2.75 by 2.5 to get the amount of gas.

2.75 \times 2.5=6.875 \mathrm{~l}

Ratio problem solving FAQs

A ratio is a comparison of two or more quantities. It shows how much one quantity is related to another.

A recipe calls for 2 cups of flour and 1 cup of sugar. What is the ratio of flour to sugar? (2 : 1)

In middle school ( 7 th grade and 8 th grade), students transition from understanding basic ratios to working with more complex and real-life applications of ratios and proportions. They gain a deeper understanding of how ratios relate to different mathematical concepts, making them more prepared for higher-level math topics in high school.

The next lessons are

• Converting fractions, decimals and percentages

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How to Calculate Ratios

Last Updated: January 29, 2024 References

This article was co-authored by Grace Imson, MA . Grace Imson is a math teacher with over 40 years of teaching experience. Grace is currently a math instructor at the City College of San Francisco and was previously in the Math Department at Saint Louis University. She has taught math at the elementary, middle, high school, and college levels. She has an MA in Education, specializing in Administration and Supervision from Saint Louis University. This article has been viewed 3,151,740 times.

Ratios are mathematical expressions that compare two or more numbers. They can compare absolute quantities and amounts or can be used to compare portions of a larger whole. Ratios can be calculated and written in several different ways, but the principles guiding the use of ratios are universal to all.

Practice Problems

Understanding Ratios

• Ratios can be used to show the relation between any quantities, even if one is not directly tied to the other (as they would be in a recipe). For example, if there are five girls and ten boys in a class, the ratio of girls to boys is 5 to 10. Neither quantity is dependent on or tied to the other, and would change if anyone left or new students came in. The ratio merely compares the quantities.

• You will commonly see ratios represented using words (as above). Because they are used so commonly and in such a variety of ways, if you find yourself working outside of mathematic or scientific fields, this may the most common form of ratio you will see.
• Ratios are frequently expressed using a colon. When comparing two numbers in a ratio, you'll use one colon (as in 7 : 13). When you're comparing more than two numbers, you'll put a colon between each set of numbers in succession (as in 10 : 2 : 23). In our classroom example, we might compare the number of boys to the number of girls with the ratio 5 girls : 10 boys. We can simply express the ratio as 5 : 10.
• Ratios are also sometimes expressed using fractional notation. In the case of the classroom, the 5 girls and 10 boys would be shown simply as 5/10. That said, it shouldn't be read out loud the same as a fraction, and you need to keep in mind that the numbers do not represent a portion of a whole.

Using Ratios

• In the classroom example above, 5 girls to 10 boys (5 : 10), both sides of the ratio have a factor of 5. Divide both sides by 5 (the greatest common factor) to get 1 girl to 2 boys (or 1 : 2). However, we should keep the original quantities in mind, even when using this reduced ratio. There are not 3 total students in the class, but 15. The reduced ratio just compares the relationship between the number of boys and girls. There are 2 boys for every girl, not exactly 2 boys and 1 girl.
• Some ratios cannot be reduced. For example, 3 : 56 cannot be reduced because the two numbers share no common factors - 3 is a prime number, and 56 is not divisible by 3.

• For example, a baker needs to triple the size of a cake recipe. If the normal ratio of flour to sugar is 2 to 1 (2 : 1), then both numbers must be increased by a factor of three. The appropriate quantities for the recipe are now 6 cups of flour to 3 cups of sugar (6 : 3).
• The same process can be reversed. If the baker needed only one-half of the normal recipe, both quantities could be multiplied by 1/2 (or divided by two). The result would be 1 cup of flour to 1/2 (0.5) cup of sugar.

• For example, let's say we have a small group of students containing 2 boys and 5 girls. If we were to maintain this proportion of boys to girls, how many boys would be in a class that contained 20 girls? To solve, first, let's make two ratios, one with our unknown variables: 2 boys : 5 girls = x boys : 20 girls. If we convert these ratios to their fraction forms, we get 2/5 and x/20. If you cross multiply, you are left with 5x=40, and you can solve by dividing both figures by 5. The final solution is x=8.

Grace Imson, MA

Look at the order of terms to figure out the numerator and denominator in a word problem. The first term is usually the numerator, and the second is usually the denominator. For example, if a problem asks for the ratio of the length of an item to its width, the length will be the numerator, and width will be the denominator.

Catching Mistakes

• Wrong method: "8 - 4 = 4, so I added 4 potatoes to the recipe. That means I should take the 5 carrots and add 4 to that too... wait! That's not how ratios work. I'll try again."
• Right method: "8 ÷ 4 = 2, so I multiplied the number of potatoes by 2. That means I should multiply the 5 carrots by 2 as well. 5 x 2 = 10, so I want 10 carrots total in the new recipe."

• A dragon has 500 grams of gold and 10 kilograms of silver. What is the ratio of gold to silver in the dragon's hoard?

• The dragon has 500 grams of gold and 10,000 grams of silver.

• Example problem: If you have six boxes, and in every three boxes there are nine marbles, how many marbles do you have?

One common problem is knowing which number to use as a numerator. In a word problem, the first term stated is usually the numerator and the second term stated is usually the denominator. If you want the ratio of the length of an item to the width, length becomes your numerator and width becomes your denominator.

Community Q&A

You Might Also Like

• ↑ http://www.virtualnerd.com/common-core/grade-6/6_RP-ratios-proportional-relationships/A
• ↑ http://www.purplemath.com/modules/ratio.htm
• ↑ http://www.helpwithfractions.com/math-homework-helper/least-common-denominator/
• ↑ http://www.mathplanet.com/education/algebra-1/how-to-solve-linear-equations/ratios-and-proportions-and-how-to-solve-them
• ↑ http://www.math.com/school/subject1/lessons/S1U2L2DP.html

About This Article

To calculate a ratio, start by determining which 2 quantities are being compared to each other. For example, if you wanted to know the ratio of girls to boys in a class where there are 5 girls and 10 boys, 5 and 10 would be the quantities you're comparing. Then, put a colon or the word "to" between the numbers to express them as a ratio. In this example, you'd write "5 to 10" or "5:10." Finally, simplify the ratio if possible by dividing both numbers by the greatest common factor. To learn how to solve equations and word problems with ratios, scroll down! Did this summary help you? Yes No

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Course: 6th grade   >   Unit 1

• Ratios on coordinate plane
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Part to whole ratio word problem using tables

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Video transcript

Maths with Mum

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Solving Ratio Problems

• We add the parts of the ratio to find the total number of parts.
• There are 2 + 3 = 5 parts in the ratio in total.
• To find the value of one part we divide the total amount by the total number of parts.
• 50 ÷ 5 = 10.
• We multiply the ratio by the value of each part.
• 2:3 multiplied by 10 gives us 20:30.
• The 50 counters are shared into 20 counters to 30 counters.

• 2 + 3 = 5 and so there are 5 parts in the ratio in total.
• We divide by this total number of parts to find the value of each part.
• We multiply the original ratio by the value of each part.
• We have 20:30.

• Sharing in a Ratio: Part 1

Ratio Problems: Worksheets and Answers

How to Solve Ratio Problems

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