The current ratio is the simplest liquidity metric. It measures whether a company has enough short-term assets to cover its short-term liabilities.
Formula: Current Ratio = Current Assets / Current Liabilities. Current Assets includes cash, receivables, inventory, short-term investments. Current Liabilities includes payables, accrued expenses, short-term debt, current portion of long-term debt.
A current ratio of 1.0 means assets and liabilities are exactly matched; above 1.0 indicates a cushion; below 1.0 signals possible short-term liquidity stress (the company would need to refinance or sell long-term assets to meet near-term obligations).
Industry norms vary widely: capital-light services typically run 1.0-1.5; manufacturing 1.5-2.5; tech with lots of cash often 3-5+. A ratio over 3 isn't always good — it can signal idle cash or excess inventory not being deployed efficiently.
Limitation: Current ratio treats illiquid inventory the same as cash. For sharper liquidity, use the quick ratio.
Example 1: A consumer-goods firm has current assets of Rs 5,000 cr (Rs 1,500 cr cash, Rs 1,500 cr receivables, Rs 2,000 cr inventory) and current liabilities of Rs 3,000 cr. Current ratio = 1.67 — comfortable. If inventory is slow-moving (say 6 months on hand), the underlying liquidity is weaker than the ratio suggests.
Example 2: A power-distribution company shows current ratio of 0.7. Investigation: large receivables from state government, current portion of long-term loans bunched up. The company is operationally fine because the receivables are government-guaranteed — but the headline ratio looks alarming.
Always read current ratio with the cash conversion cycle and the structure of working capital.
Disclaimer: Educational content from MintByte (ARN-314872, MFD). Examples are illustrative. SEBI Investment Adviser registration is in process; we do not recommend specific stocks.