Current Ratio

liquid or not liquid? That is the question

The Current Ratio is one of the primary liquidity ratios that measures the immediate ability of businesses to meet their short term liabilities as they fall due.

It is used often by lending institutions as part of their financial toolbox, and regularly by investors comparing different organisations for financial strength. As a business owner it's useful to keep an eye on this measure across time, as declining trends can be investigated prior to any real problems occuring. You will find that it will fluctuate from period to period though, so it needs to be combined with other more operational key performance indicators

Using an extract of a sample balance sheet we can compute:

Current Ratio = Current Assets / Current Liabilities

From the figures above, $180,521 / $66,448 = 2.72 times

This figure can vary wildly between industries. Some business just have long production times, large stocks of product ranges and long periods of customer credit. For example, chemical manufacture and textiles manufacture have lengthy production cycles, and need to hold a diverse inventory. Others however have almost immediate realisation of cash long before they have to pay suppliers. For example, a DIY retailer is an example of a business where the finished goods warehouse is the store, and customers tend to pay in cash or equivalent.

What is a suitable ratio for one business might well signal the end of another

While current assets greater than twice current liabilities can give some degree of comfort, one must be mindful of the ability to liquidate stocks. These are often worth much less than their carrying value in a distressed situation. For this reason there is the quick ratio which removes inventories of any form from this liquidity computation

It is always worth examining the details of the balance sheet to assess the speed with which the current assets could be liquidated

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