The current ratio: what it means and what it should be

If a credit analyst has time for a single indicator, it is the current ratio. It answers a simple question: what will pay the debts falling due over the next twelve months?

The formula, straight from the trial balance

Current ratio = Current assets / Current liabilities

Current assets are classes 3 and 5 plus the receivables in class 4 - inventory, trade debtors, other receivables, cash and bank accounts. Current liabilities are the obligations due within a year: suppliers, wages, taxes, short-term loans, and the portion of the long-term loan falling due next year.

That last item is often overlooked and it changes the result considerably. A company with a 3 million investment loan over 10 years carries 300,000 in current liabilities every year, even though in the trial balance the amount sits comfortably in a class 1 account.

What it should be

The "above 2" figure you will find in textbooks comes from American industry in the 1960s and has nothing to do with a grocery shop in 2026 that takes cash and pays its suppliers at 45 days. A healthy retailer can operate at 0.9 with no trouble at all, because it turns its inventory over twelve times a year.

When the indicator lies

Unsellable inventory. The current ratio takes goods at their book value. If the warehouse holds parts for a discontinued model, the figure is correct and reality is something else. That is why the quick ratio is computed as well, taking inventory out of the numerator.

Old receivables. A trade debtors balance loaded with invoices from two years ago inflates the indicator precisely in the companies with the worst collection problem.

A balance at a chosen moment. In many companies the 31 December trial balance is the prettiest of the year: collections came in before the holidays and no further purchases were made. For that reason a report on a single period says less than two periods compared.

What to do if it is too low

Three levers, in order of speed:

• Collect faster. Every day taken out of the collection period frees up money without selling any more.
• Refinance long term. Moving a current liability beyond one year changes the indicator instantly, but it costs interest. Banks know this and look at the trend as well, not only at the level.
• Reduce inventory. The slowest, but with the most durable effect, because it also attacks profitability.

The report computes all three liquidity indicators - current, quick and cash - and places them next to the collection period and inventory turnover, so you can see which of the levers actually has room to move.