What is the current ratio? Formula & examples for small businesses

Published Tuesday 29 July 2025

Table of contents

• What is the current ratio?
• Why the current ratio matters for businesses
• Current ratio formula
• Example of a current ratio calculation
• How to interpret current ratio results
• Current ratio vs quick ratio and cash ratio
• Common pitfalls when using the current ratio
• Current ratio compared with working capital and cash flow
• Monitor your current ratio in real time with Xero
• FAQs about current ratio

Key takeaways

• The current ratio measures a company’s short-term assets against its liabilities, and therefore its ability to pay its short-term debts.
• A ratio above 1.0 means a business’s assets exceed its liabilities, meaning it can cover its liabilities for now.
• The current ratio is an essential metric for assessing your business’s liquidity and therefore its financial health.
• A low ratio can point to inefficiencies in your business, while a higher ratio indicates healthy liquidity and financial stability.
• Businesses follow their current ratio to manage short-term financial obligations, plan for revenue growth, and build confidence with investors.
• The current ratio can vary by industry, with some industries reflecting lower ratios than others. This is why you should look at your own context when evaluating your finances.

What is the current ratio?

The current ratio is a type of liquidity ratio that compares a business’s short-term assets and liabilities to measure its ability to pay its short-term debts, like upcoming bills and loan repayments. You might also see it called the working capital ratio.

Why the current ratio matters for businesses

A healthy current ratio demonstrates your business’s short-term solvency and financial health. It’s a valuable metric in three main areas:

Managing short-term obligations

A strong current ratio reflects your business’s ability to pay suppliers, mortgage or rent, employee salaries (if applicable) and other short-term costs. When current assets vs current liabilities are lower, it can indicate potential financial trouble – a business with a low current ratio may struggle to meet short-term obligations without borrowing more, which can put its financial stability at risk.

Building investor and lender confidence

Lenders and investors look at your current ratio to gauge your business’s financial stability and whether it can service a loan or is worth investing in. For example, businesses with a high current ratio typically manage their liquidity well and are therefore a lower risk for investors.

Planning for growth

A healthy ratio shows you have an opportunity to invest in growth. With strong liquidity, for instance, you can confidently open a new store or invest in new technology. A strong ratio also suggests you have a safety margin to handle unexpected downturns.

A solid current ratio helps your business to stay agile and take advantage of opportunities for growth while protecting your financial stability.

Current ratio formula

Here’s the current ratio liquidity formula.

You’ll find your current assets and current liabilities on your balance sheet.

• Current assets include cash, accounts receivable, inventory, and other assets you expect to convert into cash within a year.
• Current liabilities are the obligations your business must pay within the same period, like accounts payable, short-term loans, and other debts.

You’ll find your current assets and liabilities on your balance sheet. Here’s more about balance sheets from the U.S. Small Business Administration (SBA).

Example of a current ratio calculation

A small construction business wants to determine 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 therefore:

$250,000 / $175,000 = 1.43

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

This gives the business a couple of options. It could invest in other areas with its remaining cash, or it could hang on to the cash in case its assets lose value or it is forced to take on debt.

How to interpret current ratio results

Follow these steps to understand what your current ratio says about your business’s financial health:

1. Calculate your current ratio

Divide your current assets by your current liabilities. A result of 1.0 or more means you can cover your short-term debts — generally a positive sign.

2. Assess what the ratio means

• 1.0 or higher: You likely have enough liquidity to meet short-term obligations.
• Well above 1.0: You may have excess cash or assets that could be reinvested in the business.
• Below 1.0: You might struggle to cover short-term liabilities. This isn’t always bad — growth-stage businesses often operate this way temporarily.

3. Track it regularly

Measure your current ratio at the same point each billing cycle — monthly, for example — to avoid seasonal fluctuations skewing your data.

4. Look for patterns over time

Compare your current ratio month by month. Watch for sudden drops or long-term trends that may signal cash flow concerns or over-conservatism.

5. Combine it with other financial metrics

Use your current ratio alongside tools like cash flow forecasts, profitability ratios, and working capital analysis to get a full picture of your financial health.

Current ratio vs quick ratio and cash ratio

While the current ratio is a useful measure, it only gives you a partial picture of your business’s situation. It’s best to use it with other liquidity and financial ratios to fully understand your finances.

Here are two liquidity ratios that are useful alongside the current ratio.

• Quick ratio (or acid test ratio) gives you a more conservative view of your finances – it only includes assets that can be quickly converted into cash (usually within 90 days)
• Cash ratio is the most stringent liquidity measure because it only compares cash and cash equivalents to current liabilities, and excludes all other assets

Learn more about these metrics in Xero's guide to liquidity ratios.

Common pitfalls when using the current ratio

On its own, the current ratio (like all liquidity ratios) provides only a snapshot of your finances. It also has a few limitations to keep in mind when interpreting the results.

It only gives a snapshot in time

Like most liquidity ratios, the current ratio shows a momentary view of your finances. It doesn’t reflect daily changes in cash flow or future income.

It treats all current assets as equally liquid

The current ratio doesn’t distinguish between types of assets. Cash is immediately available, but inventory or accounts receivable may take time to convert to cash.

It ignores the timing of payments

The ratio assumes liabilities are paid evenly over time, which isn’t realistic for many businesses. If your income and expenses vary by season or billing cycle, the ratio might not reflect true liquidity.

Current ratio compared with working capital and cash flow

The current ratio measures your spending power, similar to working capital, cash flow, and free cash flow. But knowing how these measures differ helps you understand your finances better.

Here’s a quick summary:

• Working capital shows you how much money your business has left after it has covered its short-term debts – things like supplier bills and loan repayments. Your working capital amount is the difference between current assets and current liabilities. Here’s how to calculate your working capital.
• Cash flow refers to the general availability of cash in your business. It’s the net amount of money moving in and out of your bank account over a specific period, and determines whether a business can pay its suppliers, employees, lenders, and owners on time. Here’s more info on cash flow.
• Free cash flow is what you have left after subtracting capital expenditure from operating cash flow. It indicates how profitable your business is by showing your remaining cash after investing in things like equipment or property. Here’s more about free cash flow.

Monitor your current ratio in real time with Xero

Xero takes care of the complex calculations for you, so you have a clear view of the cash available in your business.

Check your latest cash flow at a glance, track expenditure, and monitor financial performance indicators over time. Then easily create forecasts and projections using Xero’s reporting features, and make better-informed financial decisions.

Try Xero for free

FAQs on the current ratio

Here are some frequently asked questions about current ratio:

How does the current ratio help me judge my business’s ability to pay its short-term debts?

The quick ratio is one indicator of your business’s short-term solvency and financial health. It gives you an at-a-glance number to indicate whether your business has enough assets to cover its short-term liabilities (debts). A ratio above 1 shows you can comfortably meet your financial obligations, while a result below 1 might be a sign of cash flow problems.

Why does the current ratio change over time, and how should businesses interpret these changes?

Your current ratio can change due to seasonality, industry trends, and your business strategies. So you should interpret these changes within your context – a dip in your ratio may not mean you have cash flow problems if you’re planning for future growth or dealing with a setback.

How does the current ratio vary across different industries?

An acceptable current ratio can vary between industries quite a lot. A manufacturing company can have a higher ratio because of inventory levels, while a service-based business could have lower current assets. Get familiar with the benchmarks in your industry so you have a baseline for judging your financial stability and carrying out business liquidity management.

How does the current ratio affect investor decisions and credit evaluations?

Lenders and credit rating agencies typically use the current ratio formula to decide whether a company can meet its short-term financial obligations. A business with a high ratio is seen as a less risky bet, boosting the business’s chances of getting favorable credit terms. But if your ratio is low, you might have trouble borrowing funds or lenders might charge you higher interest rates to offset their risk.

How can I improve my business’s current ratio?

There are several ways to improve a low current ratio. For example, you could reduce your short-term debts for a lower liability and increase your current assets – by speeding up receivables or liquidating excess inventory. You can also try negotiating payment terms with your suppliers to give you more time to pay.