What is Current Ratio?
The current ratio is a monetary ratio that estimates a company’s proficiency to pay its short-term obligations. It is calculated by dividing a company’s assets by its current liabilities. A higher current ratio insinuates that a company has more assets than liabilities and is better financially able to cover its obligations.
The current assets can be converted to cash within one year, such as accounts receivable, inventory, and prepaid expenses. Current liabilities must be paid within one year, such as accounts payable, accrued fees, and taxes. The current ratio is essential to a company’s liquidity and financial health. It is one of lenders’ and investors’ most used financial ratios. Generally, a current ratio of 2:1 or higher is considered healthy, while a percentage lower than 1:1 may indicate that a company is having difficulty meeting its short-term obligations.
The current ratio should be compared to the industry average to determine how well a company performs relative to its peers. A current ratio is essential for monitoring a company’s financial health.
What is Quick Ratio?
The Quick Ratio is a ratio that reckons a company’s capability to bear off its short-term liabilities with its most liquid assets, also known as the Acid-Test Ratio. It is figured by dividing a company’s total current assets that can be readily converted to cash by its total current liabilities.
The Quick Ratio is deemed a more conventional measure of a company’s liquidity than the Current Ratio, which considers all current assets, including inventories and prepaid expenses. Including these items in the Current Ratio can make a company’s financial performance look better than it is.
The Quick Ratio is an essential measure for potential investors and creditors to assess a company’s liquidity and ability to meet its short-term obligations. Generally, a Quick Ratio of 1.0 or higher is considered satisfactory, while a ratio of less than 1.0 indicates that a company may have difficulty meeting its short-term obligations.
The Quick Ratio is a valuable tool for potential investors or creditors to assess a company’s liquidity.
Difference Between Current Ratio and Quick Ratio
- The current ratio can be more volatile than the quick ratio due to the inclusion of inventory.
- The current ratio is considered more conservative than the quick ratio because it includes inventory, which may have limited liquidity.
- The current ratio considers all current assets, including inventory and prepaid expenses, while the quick ratio only considers cash, marketable securities, and accounts receivable.
- The current ratio is calculated by dividing current assets by current liabilities, while the quick ratio is calculated by dividing current assets minus inventories by current liabilities.
- The current ratio is more used in financial analysis, while the quick ratio is more used to assess a company’s liquidity.
Comparison Between Current Ratio and Quick Ratio
| Parameters of Comparison | Current Ratio | Quick Ratio |
| Calculations | The current ratio estimates a company’s ability to meet its short-term debt obligations. | The quick ratio measures its ability to pay its current liabilities without relying on its inventory or other current assets. |
| Proficiency | It considers the ability of a company to pay current obligations with existing assets. | It considers the ability of a company to pay current obligations with only liquid assets. |
| Indicates | It indicates a company’s short-term financial health. | It shows its immediate liquidity. |
| Ideal ratio | 2:1 | 3:1 |
| Deliberates | It reflects the overall financial stability of a company. | It reflects its short-term liquidity position. |
References
- The Current Ratio in Current Position Analysis: Financial Analysts Journal: Vol 19, No 2 (tandfonline.com)
- Influence of The Ratio of Profit Margin, Financial Leverage Ratio, Current Ratio, Quick Ratio Against The Conditions and Financial Distress | Indonesian Journal of Business, Accounting and Management (step.ac.id)