Finance term
Current Ratio
Also known as: working capital ratio
Definition
The current ratio is current assets divided by current liabilities. It measures short-term liquidity — whether a business can meet its obligations due within the next 12 months. Above 1.0 means assets cover liabilities; above 2.0 is considered strong; below 1.0 signals potential cash stress.
Detailed explanation
The current ratio is one of the most commonly used liquidity ratios in financial analysis and lending. Current assets include cash, marketable securities, accounts receivable, and inventory — assets that will convert to cash within 12 months. Current liabilities include accounts payable, short-term debt, accrued expenses, and the current portion of long-term debt — obligations due within 12 months.
Lenders review the current ratio as part of underwriting to assess whether the borrower can service near-term obligations. A ratio below 1.0 means current liabilities exceed current assets — a warning sign of working-capital stress. A ratio of 1.5–2.0 is generally considered healthy for most industries. Some capital-intensive industries (utilities, grocery) operate efficiently with lower ratios; businesses with volatile cash flows (restaurants, seasonal retail) typically need higher ratios as a buffer.
The current ratio has a well-known limitation: it treats all current assets as equally liquid. Inventory, for instance, may take months to sell. This is why the Quick Ratio (which excludes inventory) is often used alongside the current ratio to get a more conservative liquidity picture.
The Federal Reserve's Small Business Credit Survey (https://www.fedsmallbusiness.org/reports/survey/2026/2026-report-on-employer-firms) documents how liquidity stress correlates with financing demand across U.S. small businesses. The FDIC's bank examination manual (https://www.fdic.gov/resources/supervision-and-examinations/examination-policies-manual/) specifies how commercial loan examiners evaluate borrower liquidity ratios including the current ratio.
◈ Worked example
- Business A: $500K current assets, $300K current liabilities. Current ratio = 1.67. Can meet short-term obligations; has $200K net working capital cushion.
- Business B: $300K current assets, $400K current liabilities. Current ratio = 0.75. Current liabilities exceed current assets by $100K — potential near-term cash stress.
- Seasonal business in December: $800K inventory (peak season), $200K cash, $250K payables. Current ratio = 4.0. But if inventory doesn't sell quickly, actual liquidity is weaker than the ratio suggests — supplement with quick ratio.
Common questions
The most-asked questions about Current Ratio — answered straightforwardly.
What is a good current ratio? +
Industry-dependent, but 1.5–2.5 is generally considered healthy across most small-business sectors. Below 1.0 is concerning; above 3.0 may indicate the business is holding too much idle cash or inventory rather than deploying assets productively. Lenders typically look for at least 1.25–1.5 when evaluating loan eligibility.
How is the current ratio different from the quick ratio? +
The current ratio includes all current assets (including inventory and prepaid expenses). The quick ratio excludes inventory and prepaid expenses, providing a more conservative liquidity test. For businesses with slow-turning inventory (auto dealers, manufacturers), the quick ratio is more relevant than the current ratio alone.
Can a profitable business have a low current ratio? +
Yes — and it's common. Profitability and liquidity are different things. A business can be highly profitable on paper (accrual accounting) but cash-poor if most of that profit is sitting in uncollected receivables or inventory. This is the classic 'profitable but broke' problem that working-capital loans and invoice financing are designed to solve.
Further reading
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