What is current ratio?

The current ratio compares assets expected to convert to cash within a year, such as cash, receivables and inventory, against obligations due within a year, such as payables, accrued expenses, lines of credit and the current portion of long-term debt. A ratio above 1.0x means current assets exceed current liabilities.

Lenders review the current ratio to gauge short-term liquidity and the borrower's cushion against a slowdown in collections or sales. It is a common financial covenant for working capital lines of credit, often set as a minimum. Analysts compare it with industry norms and track the trend, because a falling ratio can signal that the business is funding losses or growth with short-term borrowing.

A healthy current ratio can hide weak liquidity if current assets are slow-moving inventory or old receivables. Classification also matters: a line of credit that matures within the year, or long-term debt reclassified as current after a covenant default, can sharply lower the ratio. Seasonal businesses may show very different results depending on the balance sheet date, so analysts should consider the quick ratio and the cash conversion cycle as well.