Current Ratio

The current ratio (also called "working capital ratio") measures a company's ability to pay its short-term obligations. It is calculated by dividing a company's current liabilities from its current assets.

How can I use the current ratio when I invest in stocks?

  • You use the current ratio to understand the company's ability to pay off its short-term obligations, given its most liquid assets such as cash, marketable securities, and accounts receivable. It gives you an indication of the company's financial health. For example, Microsoft has a current ratio of 2.52, while Tesla has a current ratio of 1.13. This shows that Microsoft has more current assets than current liabilities to meet its short-term obligations as compared to Tesla and this is an indication that Microsoft seems to be the better investment of the two
  • However, as the quick ratio only shows a snapshot of the firm's liquidity status, it does not show how the firm's liquidity has progressed over the years. For example, Amazon's current ratio increased while Facebook's current ratio decreased over the past five years. This could indicate that even though Amazon's liquidity was lower than Facebook's in the past, it seems to be improving and could signal a substantial potential upside.
  • Furthermore, when comparing current ratios to determine which stock is a better long opportunity, it is wiser to compare stocks within the same industry as stocks from different sectors may have different credit periods. In industries where it is typical to extend credits for 90 days or longer, their stocks may have lower current ratios compared to those where short-term collections are critical.

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A

Assets

Valuable resource that someone owns with the expectation that it will provide some future benefit.

Accounts Payable

Value that represents a company's obligation to pay off short-term debts to its vendors, creditors, or suppliers.

B

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C

Cost of Goods Sold

Refers to all of the expenses directly related to the production of goods by a company.

Cash Flow

Net amount of cash that gets transferred into and out of a company.

Current Ratio

Measures a company's ability to pay its short-term obligations.

d

Debt to Equity Ratio

Used to evaluate a company's financial leverage and is calculated by dividing a company's total liabilities by its shareholder equity.

Dow Jones

Most-watched and essential stock market indexes in the world and tracks 30 large, publicly-owned blue-chip companies trading on the New York Stock Exchange (NYSE) and the NASDAQ. 

e

ETF

Asset that tracks a particular set of equities, similar to an index.

EPS

Ratio calculated as a company's profit divided by its number of shares.

f

Fund

Pool of money set aside for a specific purpose.

g

GAAP

Generally Accepted Accounting Principles ("GAAP") are a set of accounting principles, procedures, and standards issued by the Financial Accounting Standards Board (FASB).

h

Hedge Fund

Investment funds that try to beat a specific market benchmark for their investors.

i

Inventory Turnover Ratio

Ratio that shows how many times a business has sold and replaced inventory during a given period.

Index Funds

Fund designed to mimic the composition and performance of a financial market index.

j

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k

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l

Leverage

Borrowing funds to boost returns from an investment.

m

Margin

Money that a trader borrows from a broker to invest, and is calculated as the difference between the total value of an investment and the amount of the loan.

Market Cap

Means how much the stock market believes a company is worth.

n

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o

Option

A stock option is a contract that gives you the right to buy or sell a specific stock at a certain future price and date.

p

Profit

Profit is the financial benefit realized when revenue from a business is higher than the costs and taxes involved in operating that business.

Private Equity

Alternative investment class composed of funds that invest directly in private companies or that buy public companies and take them private

P/E Ratio

Number that compares a company's stock price to its earnings per share (EPS).

Put

Contract that gives investors the right to sell a specified amount of a specific security at a certain price within a certain time frame.

q

Quick Ratio

Helps investors figure out a company's capacity to pay its current liabilities without the need to sell its inventory and without additional financing.

r

Retained Earnings

How much net income a company has left over after it pays out dividends. 

Recession

Time of declining economic activity, lasting more than a few months, normally visible in real GDP, real income, employment, industrial production, and sales.

RSI

Momentum indicator

ROI

Metric that investors use to compare different investments.

ROE

Return on equity (ROE) is an indicator calculated by dividing net income by shareholder's equity (company's assets minus its debt)

s

Stimulus Package

A stimulus package is a coordinated effort by the government to increase spending and investment to "stimulate" an economy out of a downturn.

Shorting a stock

Trading strategy that tries to take advantage of the decline in a stock price by borrowing a stock and sell it now while planning to repurchase it later for a lower price.

Stock

A stock (also called equity) is essentially a piece of a corporation.

S&P 500

Market-capitalization-weighted index tracking the performance of the 500 largest U.S. companies

Stock Market

The amount of money a user has stored in a financial repository.

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