current ratio

Is the current ratio always a good measure of a firm's liquidity? Can a firm have a current ratio that is too high?

The answers are no and yes, respectively. While a high current ratio connotes that the firm can meet its maturing obligations, a high current ratio means that the firm may be tying up too many dollars in non-value-added resources. In such instances, the entity pays too much to finance its current operations. Moreover, it could improve profitability by shifting some of its current investments into longer-term, and more productive, resources.

Industry leaders, such as Dell, Coca-Cola, and Wal-Mart, usually have lower current ratios than those of their competitors. Sometimes these firms maintain such an aggressive short-term liquidity position that their current ratio falls below one (i.e., current liabilities exceed current assets). Their efficiencies allow them to meet maturing obligations while their vendors finance current operations.

Peter M. Bergevin, PhD, Professor of Accounting, School of Business, University of Redlands, Redlands, CA