The current ratio measures a company’s ability to pay off its short-term liabilities with its current assets. The current ratio is an important measure of liquidity because short-term liabilities are due within the next year.
The current ratio is calculated by dividing current assets by current liabilities.
Current Ratio = Current Assets / Current Liabilities
A business has a limited amount of time in order to raise the funds to pay for its short-term liabilities. Current assets like cash, cash equivalents, and marketable securities can easily be converted into cash in the short term. This means that companies with larger amounts of current assets will more easily be able to pay off current liabilities when they become due without having to sell off long-term, revenue generating assets.<< Back to Glossary Index