The name “current ratio” is appropriate because this important financial metric gives decision makers one of the clearest perspectives into their present performance. When companies need to know where their finances stand right now and what that means for the near future, few KPIs say more than the current ratio.
For those who have only seen the end result, you calculate the current ratio by dividing current assets by current liabilities. Typically, assets include all cash or anything that can be turned into cash within a year, and liabilities include any debt you must settle within 12 months.
The current ratio is also known as working capital because it describes how much liquid cash a company has with which to work. Much like the indicator of how much gas is left in the tank, the current ratio reveals how much of a company’s current liabilities the cash reserves cover. Said differently, it tells a company whether it can conduct business as usual for another year or whether it’s time to make serious course corrections.
As a general rule, a current ratio above one indicates a healthy financial position and a ratio close to one suggests there are just enough assets on hand to cover liabilities. However, a ratio below one sends a clear sign that a company can’t pay some portion of its bills in the coming months.
How a company interprets the current ratio depends on its individual financial posture. More universal are the best practices for tracking the current ratio over time.
First on the list of priorities is to track the ratio actively. Since it exposes something fundamental about financial performance, the current ratio needs constant attention instead of a quarterly, monthly, or even weekly update. Ideally, the number refreshes every day so that decision-makers know where a company stands based on the newest information available.
For the same reasons, decision makers need to track the current ratio historically and analytically. In isolation, the ratio reveals very little. Having just one number says nothing about whether the ratio is trending up or down or why. To understand the direction of the current ratio and the drivers behind it, you need to track how the ratio evolves over time within the context of other financial KPIs.
That’s why many finance and accounting departments are using dashboards to track the current ratio. It gives them an immediate calculation that’s updated as soon as the numbers change so that decision makers immediately know when the current ratio switches directions or falls above/below the 1.0 mark. Basically, decision-makers can pay as much attention to this metric as it deserves without having to spend any time hunting down the numbers or running the calculations.
Fortunately, dashboards have never been more accessible or knowledgeable than they are now. With minimal time, experience, expertise, or expense, companies can build a customized current ratio dashboard that runs automatically. That’s possible thanks to innovations from insightsoftware, an industry leader in financial reporting and dashboard solutions. When you’re ready to experience how having a dashboard can change your day-to-day decision making, download one here for free.