Definition:

The Current Ratio is a financial metric that measures a company's ability to pay its short-term liabilities with its short-term assets.

Formula:

Current Ratio = Current Assets / Current Liabilities

How to use the metric:

The Current Ratio is used to assess a company's liquidity position. A ratio above 1 indicates that the company has more current assets than current liabilities, suggesting good short-term financial health. Conversely, a ratio below 1 may indicate potential liquidity issues.

Limitations:

The Current Ratio does not account for the quality of current assets, such as how quickly inventory can be converted to cash. It also does not consider the timing of cash flows, which can affect a company's ability to meet short-term obligations.

Applies to:

The Current Ratio is applicable across most industries, particularly those with significant inventory and receivables, such as retail and manufacturing.

Doesn't apply to:

The metric may be less relevant for industries with unique working capital structures, such as financial services, where liabilities are often matched with specific assets, or technology companies with minimal inventory.

Summary:

The Current Ratio is a key liquidity metric that helps evaluate a company's ability to cover its short-term obligations. While useful, it should be considered alongside other financial metrics and industry-specific factors to provide a comprehensive view of financial health.