What does the current ratio measure?

The current ratio measures the liquidity position of a business, assessing its ability to meet short-term obligations using its current assets. This financial metric is calculated by dividing a company’s current assets by its current liabilities. A higher current ratio indicates that a company has more assets readily available to pay off its short-term debts, which is essential for maintaining operations and financial stability.

Understanding liquidity is critical for management, investors, and creditors, as it highlights how well a company can manage its working capital and respond to unexpected financial situations. In contrast, other metrics mentioned do not focus on the immediate capability to cover short-term liabilities. Long-term solvency pertains to a company's ability to meet long-term obligations, profitability reflects the company's ability to generate earnings relative to revenue, and return on equity measures the profitability in relation to shareholders’ equity. Thus, the focus on liquidity with the current ratio directly correlates to the short-term financial health of a business.