Today we will look at the current ratio, a liquidity ratio helping us determine companies able to pay short-term obligations.
The formula for the current ratio equals:
Current Ratio = Current Assets ÷ Current Liabilities
We can find each part of the ratio in the balance sheet.
Current Assets typically contains:
💰Cash & Equivalents
Current Liabities typically contains:
Let's use $AMZN
's balance sheet from above to calculate the current ratio, everything listed in $ millions
- Current assets = 161,580
- Current liabilities = 142,266
Current ratio = 161,580 ÷ 142,266 = 1.14
A ratio under 1.00 indicates that the company’s debts due in a year or less are greater than its assets—cash or other short-term assets expected to be converted to cash within a year or less. A company with a current ratio < 1 may seem bad, it may have extenuating reasons. Depending on when a company reports, the normal cycle for the company’s collections and payment processes may lead to a high current ratio as they receive payments, but a low current ratio as those collections wane.
Also some larger retailers such as $WMT
, can negotiate much longer-than-average payment terms with their suppliers. Large retailers can also minimize their inventory volume through an efficient supply chain. Making their current assets shrink against current liabilities, resulting in a lower current ratio. For example:
In theory, the higher the current ratio, the more capable a company is of paying its obligations because it has a larger proportion of short-term asset value relative to the value of its short-term liabilities. The current ratio can be useful for a company’s short-term solvency when placed in the context of what has been normal for the company and its peer group. It also offers more insight when calculated over several periods.