Current Ratio measures the ability of your organization to pay all of your financial obligations in one year. This ratio accounts for your current assets, such as account receivables, and your current liabilities, such as account payables, to help you understand the solvency of your business. Generally speaking, a ratio between 1.5 and 3 is preferable and indicates strong financial performance.
A current ratio of less than 1 indicates that your organization would be unable to meet all of your financial obligations if they came due at the same time. While this certainly is not good, it's not uncommon for organizations to operate in the red for short periods of time, especially if the business is funding growth by accumulating debt. On the other hand, a high current ratio may be mean that the business is sitting on a large amount of cash, instead of investing it back into the business.
Current ratio provides investors and financial analysts with an indication of the efficiency of your company's operating cycle. In other words, is your business able to generate a constant revenue stream and collect account receivables in a timely manner? These important questions tell potential investors a lot about the financial health of your organization.
- Assets: An economic resource that has cash value.
- Liability: A financial obligation that stems from previous transactions, such as a purchase order.
- A current ratio between 1.5 and 3.
- A current ratio that is greater than 1 and that is stable over the long term.