What you probably didn’t learn at any accounting conference this year
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The current ratio is important for both judging how much debt a business has and how flexible they are with cashflow.
A company's current ratio is calculated by dividing its current assets by its current liabilities.
Where we see this ratio used is in assessing the company's ability to meet short-term obligations. It's important to note that a current ratio is just a small part of the picture of the financial health of the business and that more analysis is needed when problems are found.
A current ratio of under 1.0 means the company is less likely to be able to pay off its obligations by year-end. This indicates debts are greater than assets.
Despite the alarming sounding name, higher current ratios can actually be advantageous. The company is in a better financial position to pay off debt by year end and have more cash flow to reinvest. But current ratios of higher that 3.0 or 4.0 can suggest a company isn't making enough investments in current assets or managing its working capital.
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