An acceptable current ratio varies by industry. Generally speaking, the more liquid the current assets, the smaller the current ratio can be without cause for concern. For most industrial companies, 1.5 is an acceptable current ratio. As the number approaches or falls below 1 (which means the company has a negative working capital), you will need to take a close look at the business and make sure there are no liquidity issues. Companies that have ratios around or below 1 should only be those which have inventories that can immediately be converted into cash. If this is not the case and a company's number is low, you should be seriously concerned.
Inefficiency
If you're analyzing a balance sheet and find a company has a current ratio of 3 or 4, you may want to be concerned. A number this high means that management has so much cash on hand, they may be doing a poor job of investing it. This is one of the reasons it is important to read the annual report, 10K and 10Q of a company. Most of the time, the executives will discuss their plans in these reports. If you notice a large pile of cash building up and the debt has not increased at the same rate (meaning the money is not borrowed), you may want to try to find out what is going on.Microsoft has a current ratio in excess of 4, a massive number compared to what it requires for its daily operations. The company has no long term debt on the balance sheet. What are they planning on doing? No one knew until the company paid its first dividend in history, bought back billions of dollars worth of shares, and made strategic acquisitions.
Although not ideal, too much cash on hand is the kind of problem a smart investor prays for.
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This page is part of Investing Lesson 3 - Understanding the Balance Sheet. To go back to the beginning, see the Table of Contents. If you have already read this lesson, you can skip directly to the Balance Sheet Quiz.
