Current ratio, also known as Current Ratio in English, is a measure of a listed company's ability to pay its short-term liabilities due within one year. It is similar to the quick ratio and cash ratio, but not exactly the same. The current ratio is calculated by dividing a company's current assets by its current liabilities. Current assets usually include cash and cash equivalents, marketable securities, accounts receivable, prepaid expenses and inventory, etc. These assets can usually be converted into cash within one year. Current liabilities refer to a company's short-term debt, accounts payable, accrued liabilities and other debts that need to be repaid within one year. Generally speaking, a current ratio greater than 2 indicates that the company has a strong ability to repay short-term debt. When a company's current ratio is less than 1, it means that the company's current assets are insufficient to pay its current liabilities, which is a relatively dangerous signal. Another indicator often used in conjunction with the current ratio is called "net working capital," which measures the difference between current assets and current liabilities. When calculating a company's current assets, you can add the company's cash and cash equivalents, marketable securities, accounts receivable, current inventory and prepaid expenses, that is: Current assets = cash and cash equivalents + marketable securities + accounts receivable + inventory + prepaid expenses When calculating current liabilities, the company's short-term debt (Short-Term Debt), accounts payable (Accounts Payable), accrued liabilities (Accrued Liabilities) and other debts (Other Debts) are added, that is: Current liabilities = short-term debt + accounts payable + accrued liabilities + other debts All of this data can be found on the Balance Sheets in a company's financial reports. Current ratio calculation example This chapter will perform example calculations by using Apple's 10-K financial report released in September 2021: The balance sheet from AAPL's financial report looks like this: From the datasheet it can be found: Cash and cash equivalents $34,940 million Marketable securities $27,699 million Accounts receivable $26,278 million Current inventory inventory (Inventory) $6,580 million Vendor non-trade receivables $25,228 million Other current assets $14,111 million Short-term debt $9,613 million Accounts payable $54,763 million Accrued liabilities and other debts $47,493 million So Apple’s fiscal 2021 midyear: Current assets = cash and cash equivalents + marketable securities + accounts receivable + current inventory + prepaid expenses = $34,940 million + $27,699 million + $26,278 million + $6,580 million + $25,228 million + $14,111 million = $134,836 million Current liabilities = short-term debt + accounts payable + accrued liabilities and other debts = $9,613 million + $54,763 million + $47,493 million
= $111,869 million Current ratio = current assets/current liabilities = $134,836 M / $111,869 Million = 1.21 This shows that Apple's current ratio for fiscal year 2021 is 1.21. What investment guidance does the current ratio have? By calculating the current ratio, you can help analyze whether a company is a good investment object. Through the current ratio of a single period, you can analyze the company's sufficient current assets in the current period. By analyzing the current ratio over a period of time, you can learn about the company's operating capabilities during this period and whether it can continue to increase its ability to repay short-term debts. When analyzing as a single data, 1, 1.5, and 3 are usually used as several important comparison indicators. Current ratio <1 The company's current assets are insufficient to pay its current current liabilities, which is a relatively dangerous situation and may even lead to bankruptcy; 1≤Current ratio is less than 1.5 Indicates that the company's current current assets can fully cover its current liabilities, but after all current liabilities are repaid, the assets used to expand the company's operations are very limited; 1.5≤current ratio＜3 It is a relatively good current ratio, which usually indicates that the company has enough current assets to repay its current liabilities, but at the same time it does not hoard too many current assets and use part of the current assets to expand the company's size; 3 is less than the current ratio It is usually considered to be an excessively high current ratio. Although a high current ratio means that the company has strong financial ability to deal with all current liabilities, it also hoards too many current assets without using them for the company's expansion. This means that the company's growth rate may be limited or slowed down, and investors' investments are not effectively used in operations to generate efficient returns on investment. What are the limitations of using the current ratio? If a company's financial capabilities are analyzed only through the current ratio, the results will often deviate greatly due to some factors. The influencing factors include: Inventory inventory Because inventory is included in the calculation of the current ratio, for companies such as large supermarkets, the current ratio value will show very obvious cyclical fluctuations. Before various holidays, supermarkets often increase inventory to cope with consumer demand. This is because the current ratio value will increase with the increase in inventory. When the inventory decreases significantly after the holidays, the current ratio value will decrease significantly, so it is difficult to measure whether the operation of this type of company is good or bad through changes in the current ratio value. Debt repayment methods Some companies will use lines of credit to repay debts. Under such a model, the company's cash stock will often be very low. When calculated through the current ratio calculation formula, the result will be very low, but in fact, the company may have sufficient debt repayment ability, so it is impossible to accurately analyze the current liability repayment ability of such companies through the current ratio. Cross-industry analysis The current ratio, like most financial analysis data, is difficult to analyze the operating status of companies across industries because the arrangement of current assets in different industries will be very different. When using the current ratio for comparison, it is impossible to accurately analyze and compare the financial capabilities of companies in different industries.