Current Ratio Formula – Working Capital Ratio Formula, How to Calculate It and Examples

Current Ratio, also called Working Capital Ratio does belong to the category of liquidity ratios, indicating ability of the business to fulfill its obligations when due. Here you can explore how to calculate current current ratio and what does it show.

Current ratio compares current assets of the business with the current liabilities in order to provide an estimation whether the business does have sufficient quite liquid assets to cover those liabilities which are also current.

Current Ratio calculation formula is as follows:

Current ratio = Current Assets / Current Liabilities

In case the value of the working capital ratio is below 1, this would mean that current liabilities of the business do exceed current assets. Such value is an indication of not sufficiently good financial health, however of course this does not mean that the business will become insolvent.

Very high current ratio values are also not goods, since that would lead to an indication the business has excess assets which are being financed by equity, not by current liabilities, being usually quite cheap.

In the same way as with other ratios, it is necessary to compare this one across the same industry and across various periods of time to have a proper view on the status of liquidity.

Also it is important to understand that the main limitation of current ratio (working capital ratio) is that it does include all current assets into calculation. Some of those (like inventory) might not be so easy converted into cash, therefore this ratio might not well represent real picture in respect of a particular business liquidity.

The better way is to use other liquidity ratios in conjunction with current ratio. These can be acid test (quick) ratio, which does exclude inventory from the calculation and compares only very liquid assets with current liabilities. Also cash ratio can be used, as it only does compare cash and current liabilities, showing immediate liquidity status of the business.

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