The current ratio indicates the extent to which current liabilities can be covered by current assets.
Current assets include inventory, accounts receivable, cash, and securities.
Current liabilities include accounts payable, short-term notes, current portion of long term debt, and accrued expenses.
Formula for Current Ratio
\[Current\,ratio = \frac{{Current\,assests}}{{Current\,liabilities}}\]
Example
Reliance Industries has currents assets of Rs.89,465 and current liabilities in the amount of Rs.24,652. This gives a current ratio of 3.63.
This means the company has almost Three and a half times more current assets than its current liabilities. This number is useful for comparison with industry trends but includes so many items from the financial statements that a deeper dive is often required to determine if a ratio is good.
Note: A company using a just-in-time inventory system may have low inventory, making their current ratio lower but not necessarily indicating that there is a problem with meeting short-term obligations. Likewise, a company with bloated inventory may have a high current ratio and still have problems meeting short-term obligations.
