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Current Ratio interpretation

Current Ratio is a liquidity ratio that measures company's ability to pay its debt over the next 12 months or its business cycle. Current Ratio formula is:

Current Ratio Formula

Current ratio is a financial ratio that measures whether or not a company has enough resources to pay its debt over the next business cycle (usually 12 months) by comparing firm's current assets to its current liabilities.

Acceptable current ratio values vary from industry to industry. Generally, a current ratio of 2:1 is considered to be acceptable. The higher the current ratio is, the more capable the company is to pay its obligations. Current ratio is also affected by seasonality.

If current ratio is bellow 1 (current liabilities exceed current assets), then the company may have problems paying its bills on time. However, low values do not indicate a critical problem but should concern the management. One exception to the rule is considered fast-food industry because the inventory turns over much more rapidly than the accounts payable becoming due.

Current ratio gives an idea of company's operating efficiency. A high ratio indicates "safe" liquidity, but also it can be a signal that the company has problems getting paid on its receivable or have long inventory turnover, both symptoms that the company may not be efficiently using its current assets.

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