What Is Current Ratio?

By Andrew Stotz | August 10, 2020

Definition of Current Ratio

The current ratio or working capital ratio is a liquidity ratio that measures a firm’s ability to pay its short term liabilities.
Short term liabilities are debts or any obligation that is due within one year.
An ideal current ratio is between 1.2 and 2.
If the ratio is low, it means the firm does not have enough liquid assets to offset its short term liabilities.
If the ratio is high, it means the firm has too many liquid assets and is not utilizing them.

The current ratio is calculated by dividing current assets by current liability.

Current ratio = Current asset / Current liabilities

Assume that Bleu waters has:
Current asset:
- Cash $ 30,000
- Account receivable $20,000
- Marketable security $20,000
- Prepaid expense $15,000
- Inventory $15,000
Current liabilities:
- Account payable $50,000
- Term debt $30,000
Bleu waters’ current ratio is:
- ($ 30,000 + $20,000 + $20,000 + $15,000 + $15,000)/ ($50,000 + $30,000)= 1.25
- The firm has a good current ratio.

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