Current Ratio Formula

What is the Current Ratio Formula?

The current ratio formula is classified as a liquidity ratio that indicates a company’s ability to pay off its current liabilities, mainly due within one year.

The Current Ratio formula is,

For example, according to the Walmart Annual Report, their current assets and current liabilities for the fiscal year ending on January 31, 2022, were $81.070 and $87,379, respectively. As per the formula, Walmart’s current ratio will be $81.070/$87,379 = 0.93.

Key Highlights

• The current ratio formula is a financial metric used to calculate a company’s ability to sort its due debts within a year.
• The formula divides a company’s current assets by its current liabilities.
• A ratio higher than 1.2 or 2 is considered a good ratio indicating that the company is using its assets efficiently.
• A company with a low ratio of less than 1 doesn’t mean the company is bankrupt.
• It explains to investors and analysts how a business can use its current assets to the fullest extent possible to pay down its current liabilities and other payables.

Current Ratio Formula

The current ratio formula is,

Here,

• Current assets are short-term holdings that can be liquidated within a calendar year or through an accounting period, such as cash and cash equivalents, short-term investments, etc.
• Current liabilities are short-term obligations intended to be paid off within a year or an accounting period.

Explanation

• The current ratio formula lets the investor know whether a company can generate enough cash to pay back its short-term liabilities.
• Fundamental research analysts extensively use the ratio while valuing a company and measuring a firm’s liquidity.
• It measures the company’s liquidity/working capital management. Thus, the higher the ratio, the more current assets a company has compared to its liabilities.
• One must analyze the ratio in the background of the company’s industry. It could also be better if we analyze the ratio over time.
• We can compare the company’s current ratio with its industry peers with a similar business model to decide the industry standard level of liquidity.
• A high ratio is not necessarily good, and a low ratio is not necessarily bad.

Interpretation

It is an ideal indicator of a company’s liquidity and ability to pay off its outstanding debt by analyzing its current assets and current liabilities. A good current ratio will also depend on the size and type of industry the company is in. Big companies generally have higher current ratios as they generate higher revenue.

• When the Current Assets > Current Liabilities, or Current Ratio > 1: This indicates that a company has enough assets to pay off its short-term debts and is in a very desirable position.
• When the Current Assets = Current Liabilities, or Current Ratio = 1:  This indicates that the company’s current assets are sufficient to pay off its short-term obligations.
• When the Current Assets < Current Liabilities, or Current Ratio < 1: This indicates that the company doesn’t have sufficient assets to pay off its short-term debt and is certainly not in a good position. However, this doesn’t mean that the company will go bankrupt.

How to Calculate the Current Ratio Formula? Excel examples

Example #1

Food & Hangout outlet sells fast food items in Texas. As a business expansion strategy, the company is applying for a loan to open its outlets in the Texas suburbs. The bank asks for the company’s balance sheet to analyze its current liquidity position. According to Food & Hangout outlet’s balance sheet, current liabilities were $100,000, and current assets were $200,000. Calculate the current ratio for the Food & Hangout outlet.

Given,

Solution: 

The current ratio for Food & Hangout outlets is 2, which means they have enough current assets to pay back their current liabilities. This shows that the Food & Hangout outlet’s business is less leveraged and has negligible risk. Banks always prefer a current ratio of more than 1, so all the current liabilities can be covered by current assets. Since the Food & Hangout outlet’s ratio is more than 1, it is for sure that it will get the loan approval.

Example #2

Alex, an investor, wants to choose a technology company to invest in. They want to calculate the current ratio for the technology company XYZ Ltd which is based in California. As per the company reports, they have $500,000 in current assets and $1,000,000 in current liabilities.

Given,

Solution: 

From the above calculation, we can say that for every dollar in current liabilities, there is only $0.5 in current assets. This means the business is highly leveraged and also has high risk. Therefore, investing in this company might lead to a loss for Alex.

Example #3

Let’s assume a company ABC holds the following data at the end of the fiscal year 2022:

• Cash= $20,000
• Inventory= $10,000
• Marketable securities= $25,000
• Accounts payable= $30,000
• Short-term debt= $30,000

Calculate the current ratio for the company ABC.

Given,

Solution: 

First, let us calculate the current assets,

Then we compute the current liabilities,

Implementing the current ratio formula,

The ABC company currently has a ratio of 1, which means it will be difficult to pay off its outstanding liability. A ratio of 1 or less than 1 indicates that the company’s due obligation is more than its assets. In such a case, the ABC company will convert short-term assets into payable cash within this time.

Real-World Examples

#1 Amazon’s Current Ratio

Let’s take the example of Amazon Inc. The company has provided the current assets and current liabilities data in its annual report for the financial year ending on December 31, 2021.

(Image Source: Amazon’s Annual Report 2021)

From the balance sheet, we can infer that the company’s current assets were worth $161,580, and the current liabilities were $142,266. Let’s find the company’s ratio by implementing the current ratio formula.

As per the annual report of Amazon,

Current assets: $161,580

Current liabilities: $142,266

Solution:

Implementing the current ratio formula,

Current Ratio = $161,580/$142,266 = 1.14

Therefore, Amazon’s Current Ratio is 1.14 during the year 2021. While a low current ratio (values less than 1) may indicate that a firm is having difficulty meeting current obligations, it may also reflect the organization’s ability to borrow against good prospects to meet current obligations. Strong businesses that can turn inventory faster than due dates on their accounts payable may also have a current ratio of less than one.

#2- Coca Cola’s Current Ratio

Let’s take the example of Coca-Cola. The company has provided the current assets and current liabilities data in its annual report for the financial year ending on December 31, 2021.

(Image Source: Coca-Cola Annual Report 2021)

From the balance sheet, we can infer that the company’s current assets were worth $1,076,662, and the current liabilities were $834,856. Let’s find the company’s ratio by implementing the current ratio formula.

As per the annual report of Coca-Cola,

Current assets: $1,076,662

Current liabilities: $834,856

Solution:

Implementing the formula,

Current Ratio = $1,076,662/$843,856 = 1.28

Therefore, Coca-Cola’s Current Ratio is 1.28 during the year 2021. While a low current ratio (values less than 1) may indicate that a firm is having difficulty meeting current obligations, it may also reflect the organization’s ability to borrow against good prospects to meet current obligations. Strong businesses that can turn inventory faster than due dates on their accounts payable may also have a current ratio of less than one.

#3- Netflix’s Current Ratio

Let’s take the example of Netflix.Inc. The company has provided the current assets and current liabilities data in its annual report for the financial year ending on December 31, 2021.

(Image Source: Netflix’s Annual Report 2021)

From the balance sheet, we can infer that the company’s current assets were worth $8,069,825, and the current liabilities were $8,488,966. Let’s find the company’s ratio by implementing the current ratio formula.

As per the annual report of Netflix,

Current assets: $8,069,825

Current liabilities: $8,488,966

Solution:

Implementing the current ratio formula,

Current Ratio = $8,069,825/$8,488,966 = 0.95

Therefore, Netflix’s Current Ratio is 0.95 during the year 2021. While a low current ratio (values less than 1) may indicate that a firm is having difficulty meeting current obligations, it may also reflect the organization’s ability to borrow against good prospects to meet current obligations. Strong businesses that can turn inventory faster than due dates on their accounts payable may also have a current ratio of less than one.

Current Ratio on the Balance Sheet

It’s quite evident that we need to find a company’s current assets and liabilities to calculate the ratio. We can find them in a company’s balance sheet and the factors contributing to the current assets and liabilities.

If you go through the balance sheet of any company, you can see the following current assets:

• Cash & cash equivalents
• Short-term deposits
• Marketable securities
• Trade & account receivables
• Inventories
• Trade & Prepaid expenses
• other current assets, etc.

Whereas current liabilities include the following:

• Short-term debt to be repaid within 1 year
• Trade & account payables
• Current portion of long-term debt
• Accrued expenses
• Taxes payables
• Deferred revenue, etc.

Let’s understand it better with the help of an example:

#Example- McDonald’s

In the annual report of 2021, we can find the balance sheet of McDonald’s. The balance sheet reflects the current assets and liabilities that the company holds. Attached below is the representation of the same:

(Image Source: McDonald’s Annual Report 2021)

Referring to the balance sheet, the current assets for the company for the fiscal year 2021 are $7,148.5. Whereas the current liabilities for the company for the fiscal year 2021 are $4,020. The factors contributing to this amount are as follows,

McDonald’s Current Assets (Amount in Millions)
Cash and cash equivalents	$4,709.2
Accounts and notes receivable	$1,872.4
Inventories	$55.6
Prepaid expenses & other assets	$511.3

McDonald’s Current Liabilities (Amount in Millions)
Accounts payable	$1,006.8
Lease liability	$705.5
Income tax	$360.7
Other taxes	$236.7,
Accrued interest	$363.3
Account payroll and other liabilities	$1,347

Implementing the current ratio formula, the ratio of McDonald’s will be 1.77. Here, we divide the company’s current assets, i.e., $7,148.5, by its current liabilities, i.e., $4,020.0.

Therefore, we can conclude that the ratio of McDonald’s is good enough, and the company can easily pay off its obligations.

Average Current Ratio: Industry-wise

Industry	Average Current Ratio for 2021
Real estate	5.21
Legal services	1.17
Health services	4.60
Textile Products	2.62
Food Products	2.63
Electronic and Electrical Equipments	5.08
Agricultural services	154.05
Oil and Gas extraction	3.77
Chemical Products	7.91
Primary Metal industries	2.58

(Source: ReadyRatios)

Current Vs. Quick Ratio

Current Ratio	Quick Ratio
Current ratio or working capital ratio helps calculate the proportion between the current assets and liabilities.	Quick ratio or acid test ratio helps calculate the proportion between the most convertible assets and current liabilities.
It is used to find a company’s ability to pay off its outstanding obligations within a fixed time period.	It is used to find a company’s ability to pay off any urgent obligation or requirement that arises.
It accounts for the assets that can be convertible to cash within a time period of 12 months.	It accounts for the assets that are convertible to cash within a time period of 90 days or less.
It can be considered a relaxed approach towards paying off a company’s obligations.	It can be considered a more strict or rigid approach towards paying off a company’s obligations.
The favorable ratio for it is 2:1.	The favorable ratio for it is 1:1.

Importance

• It accurately analyzes a company’s overall financial health. Therefore, creditors consider this ratio when determining whether to give short-term debt to a company.
• It also illustrates how well the management is using working capital. However, using this ratio alone, you cannot evaluate a company’s short-term liquidity.
• It considers all of a company’s current assets, leaving out those that are difficult to convert into cash.
• For instance, inventory is not considered in the computation of the ratio because it is more difficult to turn it into cash than accounts receivable.
• This ratio also reveals information about the operational cycle of a business. It illustrates a company’s capacity to sell off assets to cover short-term obligations.
• It just depicts the company’s financial standing at the present time; it does not fully depict its solvency or liquidity.

Calculator

Use the following calculator for Current Ratio formula calculations.

Final Thoughts

It’s quite evident that a current ratio formula can help evaluate whether a company’s liquid assets are enough to settle its obligations. To maintain a good ratio, the company must ensure that its assets are being utilized efficiently and that there’s always room for the current assets to equal or more than the current liabilities. Therefore, always pay attention to the current ratio if a company wants to be free of debts and obligations.

Frequently Asked Questions (FAQs)

Q.1 What is the formula for the current ratio in accounting?

Answer: The formula for current ratio in accounting is current assets/current liabilities. In this formula, current assets are referred to as liquid assets or cash or cash equivalents that can be converted into payable cash in a time period of 12 months.

Q.2 Is the current ratio a percentage?

Answer: Technically, no. The current ratio is depicted in numerical form after the calculation. They are expressed as whole numbers and not percentages. Moreover, a ratio of more than 1.5 means that the company holds more assets than liabilities.

Q.3 What current ratio is good? Should it be high or low?

Answer: The more the ratio is, the high capability to pay off your due obligations. If a company’s current ratio is low, it would be challenging to pay off its debts and liabilities. Typically, a ratio of 2 is considered good for a company, and anything below it can be considered bad.

Q.4 Differentiate between the current vs. working capital ratio formula.

Answer: Technically, both the current ratio and working capital are the same. We calculate the working capital ratio by dividing the current assets by the current liabilities. It is a financial ratio that measures a company’s liquidity position or simply the ability of a company to pay off its due obligations.

Q.5 What is the current asset turnover ratio formula?

Answer: The current asset turnover ratio helps compare a company’s performance from the income statement with the financial health of a company from the balance sheet.

The formula for this is,

Asset Turnover Ratio = Net Sales / Average Total Assets. 

Where net sales are the profits made after deducting the sales allowances, discounts, and returns. Whereas the average total assets are the average aggregate assets at the end of the current or previous fiscal year.

Q.6 What is a too-high current ratio?

Answer: A ratio of as high as 3 or more indicates that the business is not utilizing its assets as it should be. It might mean that the business is not effectively using its working capital, and there might be some loopholes too.

Recommended Articles

This has been a guide to a Current Ratio formula. Here we discuss its uses along with real-world examples. We also provide you with a Current Ratio Calculator with a downloadable excel template. You may also look at the following articles to learn more –

1. Examples of Retention Ratio Formula
2. Risk Premium Formula Calculator
3. Preferred Dividend Formula Excel Template
4. Guide to Operating Profit Margin