What does a Current Ratio of 1.5 mean? Clarify the misunderstanding for dad.

Liquidity Ratio (Current Ratio) is a useful tool that stock traders and investors need to know. Some believe that the higher the current ratio, the better, but in reality, it’s more complicated. Let’s see what a current ratio of 1.5 means and why it’s important for investment decisions.

What does a Current Ratio of 1.5 mean?

Current Ratio = Current Assets ÷ Current Liabilities

If the current ratio is 1.5, it means the company has short-term assets that can be converted into cash 1.5 times the liabilities due in the next year.

For example, Amazon in its 2019 financial statements had current assets of $96.3 billion and current liabilities of $87.8 billion, resulting in a ratio of approximately 1.1, indicating it can pay its debts but just barely, with limited insight.

What are included in current assets and current liabilities?

Current Assets are resources that the company can turn into cash within a year, such as:

• Cash and deposits
• Marketable securities
• Accounts receivable (Customers owe the company)
• Inventory

Current Liabilities are obligations payable within a year, such as:

• Accounts payable
• Portion of long-term debt due this year
• Unearned revenue (Customers have paid but goods not yet delivered)

What is the ideal current ratio?

There’s no perfect number, but experts suggest:

Good range: 1.5 - 2.0

• Indicates the company has significantly more current assets than liabilities
• Good liquidity and a positive signal

Minimum acceptable: 1.0 and above

• Exactly 1.0 = borderline, riskier
• Below 1.0 = the company may struggle to pay debts

Too high (Above 2.0 clearly)

• Looks safe but may indicate inefficient use of assets
• Excess cash sitting idle instead of investing for growth

Major issues with the Current Ratio that traders should watch out for

1. Inventory is not cash

A high current ratio may be due to large inventories that are hard to sell, leading to poor asset returns.

2. Not considering cash flow

A company might have a good current ratio but actual cash inflow is slow, while debts are due soon → potential risk.

3. Accounts receivable might be uncollectible

Receivables are included in current assets, but some may be bad debts, inflating the number.

4. Does not reflect management quality

A good current ratio ≠ good management. The company might have a lot of long-term debt or low profits.

5. Industry standards vary

A ratio of 1.5 might be good in retail but low in finance; compare with industry peers.

How to use the Current Ratio in CFD trading?

Assess whether it’s interesting

• Good current ratio (1.5-2) = the company has good liquidity, possibly a safer choice for long positions
• Monitor financial statement changes; if the current ratio decreases over quarters, it could be a warning sign

Combine with other analysis tools

• Use with technical analysis
• Check cash flow (Cash Flow); if current ratio is good but cash flow is poor → beware
• Compare with other companies in the same industry

Use news announcements to time trades

• Follow earnings reports; if the current ratio is in a good range (1.5) and there are new branches or major contracts → buying opportunity
• During losses, a strong current ratio indicates a potential safety margin

Summary: How to use the Current Ratio without getting trapped

• A current ratio of 1.5 is a good level, indicating the company can generally pay its debts
• Don’t rely solely on this ratio; also consider cash flow, long-term debt, and profits
• A high ratio doesn’t necessarily mean a good company; it may reflect inefficient management
• Use the current ratio as one part of your decision-making process, not the sole factor
• Compare ratios with industry peers for a clearer picture

Traders who evaluate the current ratio alongside other financial indicators can make smarter investment decisions and reduce risks.