CURRENT RATIO

 The current ratio compares all of a company’s current assets to its

current liabilities.

 These are usually defined as assets that are cash or will be turned into

cash in a year or less and liabilities that will be paid in a year or less.

 The current ratio helps investors understand more about a company’s

ability to cover its short-term debt with its current assets and make

apples-to-apples comparisons with its competitors and peers.

 One weakness of the current ratio is its difficulty of comparing the

measure across industry groups.

 Others include the overgeneralization of the specific asset and liability

balances, and the lack of trending information.

A ratio under 1.00 indicates that the company’s debts due in a year or less

are greater than its assets—cash or other short-term assets expected to be

converted to cash within a year or less. A current ratio of less than 1.00 may

seem alarming, although different situations can negatively affect the current

ratio in a solid company.

What makes the current ratio good or bad often depends on how it is changing. A company that

seems to have an acceptable current ratio could be trending toward a situation in which it will

struggle to pay its bills. Conversely, a company that may appear to be struggling now could be

making good progress toward a healthier current ratio.

In the first case, the trend of the current ratio over time would be expected to harm the

company’s valuation. Meanwhile, an improving current ratio could indicate an opportunity to

invest in an undervalued stock amid a turnaround.

Imagine two companies with a current ratio of 1.00 today. Based on the trend of the current

ratio in the following table, for which would analysts likely have more optimistic expectations?