Intermediate3 min readFundamental Analysis and Financial Statements · 12/15
Liquidity Ratios: The Current Ratio and the Quick Ratio
A profitable company can still get squeezed if what it must pay soon exceeds what it will collect soon. Liquidity ratios measure that: the company's ability to meet its current liabilities from its current assets.
What you will learn
Compute the current ratio and the quick ratio.
See why the quick ratio leaves out inventory.
Know when a high ratio is not necessarily good.
The lesson as a short video · 20 seconds · Watch on YouTubeIn this lesson
Current ratioCurrent assets ÷ current liabilities. For each pound of current liabilities, how many pounds of current assets stand against it.
Quick ratio(Current assets − inventory) ÷ current liabilities. The same idea without inventory, the slowest item to turn into cash.
Cash ratioCash and cash equivalents ÷ current liabilities. The strictest test: only cash and its equivalents.
Current assets 430
Cash 80
Receivables 150
Inventory 200
Current liabilities 250
Payables 150
Short loans 100
The invented company Al Wadi Foods, in EGP millions.
ExampleCurrent assets are 430 and current liabilities 250. Current ratio: 430 ÷ 250 = 1.72. Without inventory of 200, 230 remains, so the quick ratio is 230 ÷ 250 = 0.92. Cash is only 80, so the cash ratio is 80 ÷ 250 = 0.32.
What do these numbers say?
A current ratio above one means current assets exceed current liabilities. But a quick ratio below one says part of that rests on inventory. If inventory does not sell quickly, the company will rely on collecting from customers or on new loans to pay.
Not all inventory is alike. Food stock sells faster than machinery or apartments. That is why the quick ratio matters more for companies whose inventory moves slowly or can lose value.
Watch outA very high ratio is not always strength. It may be idle cash, overdue customer money, or piled-up inventory. A low ratio is not always danger: a supermarket collects from shoppers at once and pays suppliers later. Compare within the sector.
Open any company's latest balance sheet from the disclosure archive, compute the current and quick ratios, and see how much of current assets is inventory.