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Current ratio

Method of calculation

Formula for current ratio: current assets / short-term liabilities

Ratio's description

This ratio indicates to what extent the company can cover its current liabilities with liquid assets, i.e. with current assets. The greater the values, the better the financial liquidity of the company. The reference values for the ratio hover around 2 (there are also other rules, e.g. that the ratio should not be less than 1.2). The level of the liquidity ratio is affected by the industry branch in which the company operates, e.g. production companies will have lower liquidity levels than trading companies.

Ratio's interpretation

  • When assessing the changes in ratio's value over time (over few periods):
    • the decrease of ratio's value is interpreted as a deterioration of financial liquidity (an increase is respectively treated as an improvement),
    • maintaining the ratio's value close to 1 is interpreted as an increased risk of financial liquidity loss,
    • maintaining the ratio's value much above 2 is interpreted as excess liquidity (the liquidity is secured, but it may result in dereased profitability and lowered efficiency in the long run).

       

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