Working Capital Ratio

Current Ratio

Measuring Liquidity: Summary of the Working Capital Ratio. Abstract

The Working Capital or Current Ratio (CUR) is a model for measuring the liquidity of a company by calculating the quotient of all current assets and all current liabilities. It is an indicator of a company's ability to pay short-term obligations.

To calculate the current ratio and the CUR formula, see the picture on the left.

This ratio is also known as the working capital ratio and real ratio and is the standard measure of a business' financial health. It will tell us whether a business is able to meet its current obligations by measuring if it has enough assets to cover its liabilities.

For example, if a corporation has has M$50 in current assets to cover M$50 in current liabilities, this means it has a 1:1 current ratio.

What is an acceptable CUR?

This varies by industry. Generally speaking, the more liquid the current assets, the smaller the CUR can be without cause for concern. For most industrial companies, 1.5 is an acceptable CUR. A standard CUR for a healthy business is close to two, meaning it has twice as many assets as liabilities.

A thing to remember when using the CUR is that it ignores timing of both cash received and cash paid out.

Take the example of a company with no bills due today, but lots of bills that are due tomorrow. The company also owns a lot of inventory (as part of its current assets). However the inventory will only be sold in the longer term. This company may show a good CUR, but can not be considered as having a good liquidity.

Book: Steven M. Bragg - Business Ratios and Formulas : A Comprehensive Guide

Book: Ciaran Walsh - Key Management Ratios

T I P : Here you can discuss and learn a lot more about Current Ratio and liquidity.

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