Can the business pay what falls due this year
The current ratio compares what a business owns that will turn into cash within a year against what it owes within the same period. It is the first liquidity test any lender or supplier applies.
It is a snapshot, not a forecast. It says nothing about whether the assets convert on time, only about whether they exist.
The formula
Current assets are cash, receivables, inventory and prepayments. Current liabilities are payables, short-term borrowing, accrued costs and the portion of long-term debt due within twelve months.
Worked example: $150,000 against $100,000
The default scenario gives a ratio of 1.5, meaning there is $1.50 of short-term assets for every $1.00 falling due. In cash terms the buffer is $50,000 — that figure is the working capital.
- Below 1.0 the business cannot cover the year from current assets alone
- Between 1.5 and 2.0 is comfortable for most trading businesses
- Well above 3.0 often signals idle cash or inventory that is not selling
Why the quick ratio usually matters more
Inventory is counted as a current asset but converts slowly, and in a crisis it converts at a discount. Strip it out and the same business may look very different.
If $100,000 of that $150,000 is stock, the quick ratio is 0.5 — one third of the headline figure. A business can show a current ratio of 1.5 and still be unable to pay a supplier next month.
What this ratio does not tell you
The timing inside the year. Receivables due in 90 days do not help with a payable due in 30. The cash conversion cycle answers that question, and this ratio does not.
It also ignores committed credit facilities, which are not assets on the balance sheet but are very much available liquidity.
Reading the ratio over time
A single reading says little. A ratio falling from 2.0 to 1.5 to 1.1 over three years describes a business consuming its buffer, even though 1.1 on its own would not trigger alarm.
Watch what is moving underneath it. A ratio held steady by rising inventory is weaker than the same ratio held steady by rising cash, because the first is unsold product and the second is settled money.
What lenders do with it
Loan agreements frequently contain a covenant requiring the ratio to stay above a stated level, commonly 1.2 or 1.25. Breaching it can make the whole facility repayable on demand, regardless of whether any payment has been missed.
If you operate under such a covenant, the ratio stops being a diagnostic and becomes a constraint. Check it before drawing down short-term credit, since new short-term borrowing raises the denominator immediately.
What a healthy figure looks like by sector
There is no universal target. A supermarket sells stock before it pays for it and routinely operates below 1.0 without any distress; a manufacturer holding months of raw material may need 2.0 to be equally safe.
Compare against businesses with the same working capital cycle rather than against a textbook number. The right question is whether the ratio is normal for the trade, and whether it is moving.
Related calculators
- Quick ratio calculator — the same test with inventory removed
- Working capital calculator — the buffer expressed in money rather than as a ratio
- Cash conversion cycle — the timing this ratio cannot see