What is the Current Ratio?
The current ratio compares two totals on a balance sheet. It is a snapshot of reported amounts, not a schedule of incoming cash and due payments.
Use the statement and its notes to understand classification and timing. The IFRS Foundation overview of IAS 1 places the statement of financial position alongside cash flows and explanatory notes; no single ratio replaces those disclosures.
How to Calculate Current Ratio
The formula for calculating the Current Ratio is simple:
Current Ratio = Current Assets ÷ Current Liabilities
Where:
- Current Assets: Use the reported total, which may include cash, inventory and receivables. Classification can reflect the normal operating cycle as well as twelve-month criteria.
- Current Liabilities: Use the reported total, which may include trade payables, accrued expenses and current debt. Use the same reporting date and units as assets.
Interpreting the Current Ratio
- Above 1.0: Reported current assets exceed current liabilities. Receivables may be collected late and inventory may not sell at its carrying amount.
- Equal to 1.0: The entered totals match. Their payment and conversion timing can still differ.
- Below 1.0: Current liabilities exceed current assets. Review the operating cycle and financing arrangements rather than treating this alone as a default prediction.
- Compare over time: Use consistent accounting and reporting dates. A change can reflect seasonality, borrowing or asset classification rather than improved cash generation.
Limitations of the Current Ratio
While useful, the Current Ratio has limitations. It includes all current assets, including inventory, which might not be easily converted to cash (liquidity). For a more stringent measure of liquidity that excludes inventory, investors often look at the Quick Ratio (Acid-Test Ratio).