What is a good current ratio?

The current ratio is a liquidity ratio that measures a firm’s ability to pay off its short-term liabilities with its current assets. The current ratio is important because short-term liabilities are due within a period of twelve months.

The current ratio is calculated using two standard figures that are shown in the company’s balance sheet: current assets and current liabilities. The formula for the same goes as:

Current ratio = Current Assets / Current Liabilities

A current ratio of 2:1 is considered ideal. Generally, a ratio between 1.5 to 2 is considered beneficial for the business, which means that the company has more financial resources (Current Assets) to cover its short-term debt (Current Liabilities).

A high current ratio may indicate that the business is having difficulties managing its capital efficiently to generate profits.

On the other hand, a lower current ratio (especially lower than 1) would signify that the company’s current liabilities exceed its current assets and the business may have difficulty covering its short-term debt. Although the definition of a good current ratio may vary in the different industry groups.

Example- Where,

1) CR is 2:1, the company is in a good situation as it has double the Current Assets in order to cover the short-term debt.

2) CR is 0.5:1, the company is not in a good situation as it has only half the Current Assets in order to cover the short-term debt.