Q:What is the difference between the current ratio and the quick ratio?
A:The current ratio and the quick ratio (also known as the acid test ratio) are commonly used to determine a company’s liquidity. In other words, these two ratios are used to determine a firm’s ability to pay current liabilities with assets that can quickly be converted into cash (if not cash already). Liquidity is clearly an important aspect of a company because it is necessary for the business to stay in operations.
The current and quick ratios vary slightly in how they are calculated. Let’s take a look at the formulas for each ratio.
Current Assets ÷ Current Liabilities
(Cash & Cash Equivalents + Short-Term Investments + Net Current Receivables) ÷ Total Current Liabilities
Current Ratio vs Quick Ratio
You will notice when you review the two formulas that the current ratio formula includes all current assets. This is not the case for the quick ratio. This ratio only uses cash & cash equivalents, short-term investments, and net current receivables. The quick ratio takes a more conservative approach compared to the current ratio. It leaves out the commonly least liquid assets such as inventory and prepaid expenses.
Let’s take a look how the two ratios are calculated using the below balance sheet information.
|Current Assets||Current Liabilities|
|Accounts Receivable (Net Current)||$5,000||Interest Payable||$1,000|
|Marketable Securities||$20,000||Accrued Expenses||$2,000|
|Government Bonds||$3,000||Taxes Payable||$4,000|
|Inventory||$10,000||Note Payable (Short-Term)||$4,000|
The current ratio is calculated as follows:
$48,000 ÷ $14,000 = 3.43:1
The quick ratio is calculated below:
($10,000 + $5,000 + $20,000 + $3,000) ÷ $14,000 = 2.71:1
Notice the difference in the two calculations is that inventory for $10,000 is included in the current ratio, but not in the more conservative quick ratio.