What is a Good Current Ratio?

The current ratio is a useful measure that indicates whether your business can meet its short-term liabilities (things you’ll need to pay for within a year) using your company’s current assets (that’s cash, and things you can quickly turn into cash, such as stock or receivable invoices). 

The current ratio is mainly used by accountants and finance teams when evaluating the financial health of a company, but many successful owners will keep a close eye on it, along with other KPIs. Understanding the numbers that underpin your business is crucial to your success, and too many business owners learn the hard way that running out of cash is the quickest route to failure. 

To work out your current ratio, divide your assets by your liabilities:

Current Ratio = Current Assets / Current Liabilities

A good current ratio is different from your cashflow position, but the two things are connected. If you have a $1000 rent payment due tomorrow, $500 in the bank, and $2000 owed to you in three days time, you’ll still miss your rent because you won’t have the cash when you need it. But your current ratio is a sign that will give confidence to your bank – or your landlord – that if they extend you a line of credit to cover that rent payment, you’ll be able to pay them back. In other words, the money that you’re owed is an asset that will quickly turn into spendable cash in the bank.

Importance of working capital ratio for your business

That’s why the current ratio, (often called the working capital ratio) is such a useful metric to watch – it’s a sign of financial health and liquidity. 

Let’s say a company has assets valued at around $200,000, and their liabilities were valued at $180,000. If you divided their assets by their liabilities, you arrive at a current ratio of 1.11. Put differently, the company’s assets are 1.11 times greater than its liabilities.

Different industries are viewed differently, but a current ratio of between 1.1 and 3.0 is usually seen as healthy – although opinions differ, as we’ll see.

And while it might seem like you need as high a current ratio as possible, that isn’t necessarily the case. If a company had a very high current ratio – say, 4 or higher – it could suggest that it’s not using its assets and capital to effectively generate more business. 

Useful for loans

Lenders want confidence that you understand all the numbers that are important to your business, and that you’re borrowing money for reasons that make sense. When you're applying for business loans, lenders will be interested in your company’s liquidity ratios. As we said earlier, a higher current ratio reassures lenders that your company can handle the debt it’s taking on. Typically, a healthy current ratio gives you a better chance of securing a loan, and it’s a good sign that you know what you’re talking about.

Attracts potential investors

For exactly the same reasons, a solid current ratio can make your business more appealing to potential investors. Investors look at your company’s financial health, and the current ratio is one of the key indicators of how well your business is able to manage its short-term liabilities. 

Personal confidence

A healthy current ratio doesn’t just help with finance and investors. If you’re on top of your figures to the extent that you’re regularly monitoring your financial KPIs, including your current ratio, it will give you the personal confidence to make decisions that could help you grow – like reinvesting in inventory, hiring new staff, or expanding your business. You’re also better positioned to make decisions around unexpected expenses or new opportunities.

What is a good current ratio?

According to a Business Insider article, a good current ratio is anything between 1.5 to 3. If this is the case, the company has more than enough cash to meet its liabilities while using its capital effectively. 

But this will vary according to the type of company you’re talking about. It might be common in certain industries to have current ratios lower than 1. Supermarkets, for instance, tend to operate at current ratios below 1 because they have few trade receivables, have a high level of trade payables, and have tight cash control. 

A successful company with a current ratio below 1 is Wal-Mart. The company has a very high level of inventory, and they’re very good at turning their inventory and collecting the receivables, so they can operate with a low current ratio and still post massive profits. 

So it’s important to benchmark yourself against other businesses in your industry. If your current ratio is lower than your industry average, that may indicate that you’re underperforming and could be in line for cash flow problems. 

Factors that influence your current ratio

Your current ratio is influenced by different aspects of your business. 

Accounts receivable

Accounts receivable is all the money customers owe you for products or services they’ve already received. 

A high accounts receivable turnover indicates that your business is efficiently collecting payments from customers. 

Inventory management

Having too much unsold stock can be a cashflow killer. Deadstock that isn’t selling can no longer convert easily to cash, so using your POS system to monitor stock that isn’t selling will influence how you calculate the current ratio.

Check out some tips on how to manage inventory for small businesses. Regularly evaluate what’s selling and what’s not, and don’t be afraid to discount slow-moving items to clear them out. 

Other current assets 

Your other current assets can also play a role in your company’s current ratio. This includes things like cash equivalents, prepaid expenses, and any other items that can be quickly converted into cash. 

Make sure you keep an eye on what’s sitting in this category and how it can affect your company’s ability to cover current liabilities.

Accounts payable 

This is all the money you owe to suppliers, creditors, and anyone else you’ve bought goods or services from, to include in your liabilities calculation. 

You can learn more about how to integrate accounts with your POS for better management.

Short-term debt

This includes any loans or credit lines that need to be paid back within a year. Again, this will add to your liabilities when calculating your current ratio. 

Business operations

If your operations are running smoothly, you’re more likely to generate steady income and manage expenses effectively. But if things are chaotic—like frequent staff turnover or inefficient processes—you might find yourself with more liabilities than assets.

Take time to analyze your operations and identify areas that could use some improvement. Streamlining processes, training your team, or adopting new technologies can help increase efficiency. 

How can an Epos Now POS system help?

An Epos Now POS system is a real boost for your business, making everything easier and helping you manage your finances better. One of the coolest features is its inventory management. You can track stock levels in real time, which helps you see what’s selling and what’s not. 

This means you can restock smartly to avoid tying up cash in extra inventory, keeping available cash in the bank instead of binding it up in assets for longer than necessary..

Plus, the system makes sales super quick. You can see your sales figures right away, which helps you know how quickly money will land in the bank. 

Epos Now also connects easily with your accounting software, so your accounts payable and receivable get updated automatically. This saves you time and cuts down on mistakes. Overall, using an Epos Now POS system can really improve how your business runs and its financial health. For more info about different systems, check out Epos Now systems.