5.2.2 Current ratio

The current ratio is the ratio of current assets to current liabilities and is calculated as follows:

This ratio assumes that the current assets can be converted into cash at their book value (i.e. at the value recorded in the accounts of the organisation), irrespective of the actual market value of the assets. In this way, current assets should provide a key flow of funds from which liabilities that are falling due within the year can be paid. The ratio carries two implicit assumptions that are unlikely to be met in a strict sense:

1. It assumes that payables (creditors) will be satisfied by payment within the year when, in practice, they will focus on a specific due date, which may be much more immediate. For example, if the trade payables allow 30 days for payment (which is a very common payment period), the bills represented by the figure in the balance sheet should probably already have been paid by the time the financial statements are released. If the business is trading normally, that set of liabilities will most likely have been replaced by a new set of roughly equal size, but suppliers may either be struggling to raise finance themselves or be concerned about the viability of their customers.
2. It also assumes that current assets will realise their book value. This may be true of some assets, such as cash or trade receivables, but it is not necessarily true of others, such as inventory, which may end up worth more than cost if sold into the retail market, or worth less if, for example, they are fashionable goods that miss their selling season. Trade receivables may not be collected fully, on the other hand.

Accepting these implicit assumptions for a moment, it is worth contemplating what the ratio implies. Logic would lead to the conclusion that if the ratio is equal to or greater than one, the company will have no liquidity crisis in the year. This, however, is too simplistic. At the very least, it ignores the time lag involved in the cycle of production, in that current assets may be illiquid at the time payment is demanded by the payables. Work in progress is a typical example since it is neither raw materials nor finished goods, either of which could be sold quickly if necessary (perhaps at a discount, but at least sold!).

Usually you would want to see a current ratio greater than one (that is, current assets greater than current liabilities). However, there are some industries that are very cash rich (e.g. supermarkets) that have low-value inventory and hardly any receivables, so their current liabilities often exceed their current assets without causing any anxiety to management. Due to the high daily cash flow from operations, there is confidence that all current liabilities will be met when due. For manufacturing businesses, which tend to have a relatively large inventory, a current ratio of about two is considered ‘safe’, but this is dependent on the actual industry. If you consider service industries – some of which require inventory (e.g. hotels or retailers) and some of which have hardly any inventory (e.g. architects or lawyers) – then giving a generalised target number for the current ratio is almost meaningless. This does not mean the ratio itself is not worthwhile, just that it needs to be seen within the context of the particular business sector.

Below is the calculation of the current ratio for Remote Sensors Plc.

In the case of Remote Sensors Plc, you can see that the ratio increased from 2023 to 2024 and declined in 2025. However, it is still 2.73 in 2025, which is well above the benchmark of 2:1 for manufacturing businesses. This ratio had been quite high in 2024, which may indicate poor inventory, cash or accounts receivables management by the company, because although a high ratio indicates good liquidity it also makes shareholders and investors question management’s ability to manage the company’s assets efficiently.

It is also sensible to consider the current ratio alongside the ‘acid test ratio’, which you will learn about in the next section.

Activity 8 provides you with an opportunity to practise calculating working capital and current ratio and will help you develop your skills for financial analysis and interpretation.