You've asked an important question...one that is critical when selecting individual stocks. But before we go over the details, I want to take a minute to define the terms involved so those BUYandHOLDers who are unfamiliar with the current ratio, will understand what we're discussing.

JARGON DEMYSTIFIED

CURRENT RATIO measures a company's ability to meet its short-term obligations. Think of it as a liquidity ratio, as a measure of the company's immediate financial health -- and whether or not it has enough short-term assets to cover its short-term debt.

Sometimes it is also called the WORKING CAPITAL RATIO.

It is calculated by dividing current liabilities into current assets. Both figures are shown on the company's balance sheet. Here's how a typical current ratio looks:

CURRENT ASSETS: This refers to a company's cash as well as those assets that can be converted into cash -- within one year, such as marketable securities, accounts receivable, inventories and prepaid expenses. Current assets typically are not very profitable but, of course, they add liquidity and thus safety to a firm's operation.

CURRENT LIABILITIES: These are debts due within one year, such as accounts payable, short-term loans from financial institutions, current maturities of long-term debt, dividends declared but not paid and expenses incurred but not paid. A company generally takes care of its current liabilities by using its current assets.

HOW YOU CAN USE THE CURRENT RATIO...

When looking at stocks to possibly add to your portfolio, the current ratio is one of the first numbers on the balance sheet you should look at. It's a way of seeing how much cash management can cough up quickly to pay liabilities. The more cash a company has, generally the better able it is to respond to tough times and the easier it is for management to introduce new products and services.

WHAT'S A FAVORABLE RATIO?

Like so many things financial, there is no one-size-fits-all answer to your question. First of all, ratios vary among different industries, so you must compare current ratios among companies in the same business. You'll find a list of current ratios for the major industries at: http://www.businessweek.com/smallbiz. (Type in "current ratio" in the search box on the home page.)

Some rules of thumb:

• A ratio of 1:1 means the company has $1 in current assets to cover $1 in current liabilities.
• Anything below 1:0 indicates a negative working capital.
• Analysts tend to think that a current ratio of 1:5 is just about enough to meet the near-term operating needs of most companies.
• However, a ratio of 2:0 is considered the norm and 2:1 is even more desirable.
• But having said that, it's also true that a slightly lower current ratio could be healthy -- if the company's current assets are mostly cash or if the company is involved in a cash-oriented business.
  
  Restaurants, for instance, often have current ratios of less than 1:1. Here, the lower ratio is acceptable because there's almost always a time lapse between payment by customers for the restaurant's services and the restaurant's payments to vendors, who generally grant the restaurant credit.
• A relatively high current ratio, say 5:0 or above, is not necessarily a positive. It may indicate that the company's assets are not being used to their best advantage -- management may be hoarding them instead of plowing them back into the business to help it grow. Or the firm may have too much inventory on hand. Or, possibly management is not investing the company's extra cash.

TIP: When you see a ratio that's significantly higher than those in its peer group, look further into how well the company is being managed. Check out the opinion offered in Value Line (http://www.valueline.com/) before buying shares.

A WORD ABOUT THE QUICK RATIO

Sometimes a company's inventories are not worth what they're listed for on the balance sheet. Think about the retail business where there are ongoing sales, markdowns, and closing-out discounts. Retail companies that have a lot of liquid assets tied up in inventory are almost totally dependent on the sale of their inventories to finance the business. An inventory that does not sell well is a disaster waiting in the wings.

That's why many analysts like the QUICK RATIO. You should use it as well. The Quick Ratio is simply current assets minus inventories divided by current liabilities.

When you take inventories out of the picture, you find out if a company has enough other liquid assets to meet its short-term needs. You want to see a Quick Ratio coming in above 1:0 -- although again, be sure to compare Quick Ratios among companies in the same industry.

BOTTOM LINE: For more tips on using the Current Ratio, click on BUYandHOLD's B&H 101 page and read Chuck Carlson's take on the matter at http://www.buyandhold.com/bh/en/education/carlson/current_ratio.html

GOOD LUCK!