Current Ratio

Can a company pay its bills over the next year? The quickest answer comes from the current ratio, one of the most basic and widely used measures of short-term financial health. It's calculated simply as current assets divided by current liabilities — comparing what a company can quickly turn into cash against what it owes in the near term.

Reading the Number

Current assets include cash, receivables, inventory and short-term investments; current liabilities include trade payables, short-term borrowings and dues falling within a year. A ratio of 1.0 means assets just cover liabilities; below 1 signals potential liquidity stress, since short-term obligations exceed short-term resources. A commonly cited healthy range is between 1.5 and 2.0 — comfortable cover without too much idle capital. But context is everything: a very high ratio (say, 4 or 5) can actually mean the company is hoarding cash or stuck with unsold inventory, an inefficient use of capital.

Industry Context Matters

There's no universal 'good' number. FMCG and retail businesses often run lower current ratios because they sell inventory fast and collect cash quickly, while manufacturing or project-based firms with long inventory cycles may need higher ratios. Comparing a company only against its own history and its sector peers is the right approach. For Indian companies, you'll also see the related quick ratio (the 'acid test'), which strips out inventory to test liquidity more strictly — useful where inventory may be slow-moving or hard to sell.

Why It Matters to Investors

The current ratio is a fast first check on liquidity and solvency risk. A consistently falling ratio, or one slipping below 1, warns of a possible cash crunch, dependence on rolling over short-term debt, or working-capital trouble — red flags that have preceded many corporate distress stories. Lenders and rating agencies scrutinise it too, as it affects a company's ability to service short-term debt. While no single ratio tells the whole story, the current ratio is an essential ingredient in assessing whether a company can weather the next twelve months without a liquidity scare.