Balance sheet
Current Ratio
The current ratio checks whether short-term assets cover short-term obligations.
Current assets are cash, receivables, and inventory expected to turn within a year. Current liabilities are bills due within a year. A ratio above 1 means the balance sheet, on paper, can meet those bills without selling long-term assets. Far below 1 is a liquidity question. Far above 2 can mean idle cash or stale inventory.
The ratio is blunt. Inventory that nobody wants counts as an asset. Deferred revenue, which is often a good sign in software (customers paid in advance), counts as a liability and makes the ratio look worse. Read the components, especially for banks, where the current ratio is not the right liquidity tool.
Formula
Current ratio = current assets ÷ current liabilities
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Questions
What number is safe?
Around 1.5 is a common comfort zone for industrial firms. The trend and the quality of the assets matter more than a round number.
How is the quick ratio different?
The quick ratio excludes inventory. It is the stricter test when stock on the shelf may not become cash quickly.