How the current ratio formula works and how your small business can use it

Published Friday 5 December 2025

Table of contents

• Current ratio definition
• Current ratio formula
• Example of a current ratio calculation
• How to interpret your current ratio
• Current ratio vs quick ratio and other liquidity ratios
• Current ratio in relation to working capital and cash flow
• What are the limitations of using the current ratio?
• Improve your current ratio monitoring with Xero
• FAQs on current ratio

Key takeaways

• Calculate your current ratio by dividing current assets by current liabilities, aiming for a ratio between 1.5 and 2.5 to indicate healthy liquidity without excess idle cash.

• Monitor your current ratio consistently at the same time each month to identify trends and ensure accurate comparisons, as this ratio fluctuates throughout billing cycles.

• Combine current ratio analysis with other financial metrics like quick ratio, cash flow forecasts, and working capital to gain a complete picture of your business's financial health.

• Recognise that a current ratio below 1.0 signals potential difficulty meeting short-term obligations and requires immediate attention, while ratios above 2.5 may indicate inefficient use of assets that could be invested for growth.

Current ratio definition

Current ratio is a liquidity ratio that measures your business's ability to pay upcoming bills and loan repayments; in fact, a ratio of over 1:1 is normally considered to be comfortable. People also call this the working capital ratio.

This ratio provides a broader view of liquidity than the quick ratio because it includes all current assets, even those that take longer to convert to cash like inventory.

Current ratio formula

To calculate your current ratio, you use two numbers from your balance sheet: current assets and current liabilities.

Current assets include:

• cash and cash equivalents
• accounts receivable
• inventory
• other assets you can convert to cash within one year

Current liabilities include:

• Accounts payable
• Short-term loans
• Other debts due within one year

Example of a current ratio calculation

A small construction business wants to work out its current ratio, to see if it can cover upcoming loan repayments and material costs.

The business has $250,000 in current assets and $175,000 in current liabilities. The current ratio calculation is:

$250,000 / $175,000 = 1.43

The current ratio is above one, which means the company can cover upcoming liabilities. For every $1 of liabilities, the company has $1.43 available.

It might also be possible for the company to invest in other areas with the remaining cash. Or, the business could hang on to its extra cash in case there's a time when its assets are lower and liabilities are higher.

How to interpret your current ratio

Current ratio interpretation depends on the specific result:

• Ratio of 1.0 or higher: Your business can cover short-term debts and is financially healthy.
• Ratio between 1.5 – 2.5: This range indicates strong liquidity without excess cash sitting idle.
• Ratio above 2.5: While financially secure, you might have too much cash that could be invested in growth opportunities.
• Ratio below 1.0: This suggests potential difficulty meeting short-term obligations, though it's common during growth phases when businesses invest heavily.

The current ratio changes over a billing cycle, so measure it at the same time every month. That way you're comparing like for like, and you can see the long-term trend of the current ratio.

Your current ratio is only one view of your finances. Combine it with other profitability ratios and cash flow forecasts to assess and manage your finances.

Current ratio vs quick ratio and other liquidity ratios

Different liquidity ratios give you different views of your financial health:

• Quick ratio (acid test ratio): Uses only assets convertible to cash within 90 days, excluding inventory for a more conservative liquidity view.
• Cash ratio: Compares only cash and cash equivalents to current liabilities, providing the most stringent liquidity measure.
• Current ratio: Includes all current assets, giving the broadest view of your ability to meet short-term obligations.

Using a combination of financial ratios can show you how much cash you have available at different times, for different purposes. Learn more in the guide to liquidity ratios.

Current ratio in relation to working capital and cash flow

How your current ratio relates to other financial metrics helps you see your full financial picture. While current ratio measures liquidity, these related metrics provide additional insights:

While the current ratio measures liquidity, these related metrics provide extra insights:

• Working capital: how much money you have left after covering current liabilities, such as supplier bills and loan repayments
• Cash flow: the net amount of money moving in and out of your business bank accounts
• Free cash flow: the cash left after you subtract capital spending from operating cash flow, which shows how much money you have available after investing in assets

What are the limitations of using the current ratio?

When you use the current ratio, keep these limits in mind:

• Snapshot timing: The ratio only reflects your financial position at a specific point in time.
• Asset quality differences: All current assets are treated equally, even though cash is immediately available while inventory may take months to convert.
• Timing mismatches: The ratio assumes all liabilities are due simultaneously, which rarely reflects reality.

Additional limitations include:

• Payment timing: Cash inflows and outflows rarely align as the ratio suggests, creating potential cash flow gaps.
• Seasonal variations: Businesses with seasonal patterns may see misleading results depending on calculation timing, as shown in one business case where the current ratio was observed dropping from 3.72 to 1.64 in a single year.
• Daily fluctuations: Cash positions change constantly, making point-in-time calculations less reliable for ongoing decisions.

Improve your current ratio monitoring with Xero

Smart accounting software simplifies current ratio monitoring by automating complex calculations and providing real-time insights:

• Automated calculations: Track your current ratio without manual spreadsheet work.
• Real-time monitoring: See cash flow and liquidity changes as they happen.
• Financial forecasting: Create projections to anticipate future liquidity needs.
• Performance tracking: Monitor trends over time to identify patterns and opportunities.

Try Xero for free to see your key numbers in one place and spend more time running your business, not your books.

FAQs on current ratio

Here are answers to some common questions about the current ratio.

What is a good current ratio?

A good current ratio is generally between 1.5 and 2.5, with some experts citing a generally acceptable current ratio of 2:1. This range suggests you have enough assets to cover your short-term debts without tying up too much cash that could be used for growth. However, the ideal ratio can vary by industry.

What does a current ratio below 1 mean?

A current ratio below 1.0 means your current liabilities are greater than your current assets. This could indicate a risk of not being able to pay your short-term bills, and as CPA Australia notes, a ratio below 1:1 needs attention as it may signal a shortage of funds. While it can happen temporarily, especially in growing businesses, a consistently low ratio is a cause for review.

Can a current ratio be too high?

Yes, a very high current ratio (for example, above 3.0) might suggest your business isn't using its assets efficiently. It could mean too much cash is sitting idle or you have too much stock, instead of being invested back into the business to fuel growth.