Quick Ratio vs Current Ratio: Whats the Difference?

The quick ratio, also known as acid-test ratio, is a financial ratio that measures liquidity using the more liquid types of current assets. Its computation is similar to that of the current ratio, only that inventories and prepayments are excluded. You can calculate the current ratio by taking current assets and dividing that figure by current liabilities. Generally, the higher the ratio, the better an indicator of a company’s ability to pay short-term liabilities. Current assets are assets that can be converted to cash within a year or less.

For example, consider prepaid assets that a company has already paid for. It may not be feasible to consider this when factoring in true liquidity, as this amount of capital may not be refundable and already committed. The range used to gauge the financial health of a company using the current ratio metric varies on the specific industry. It considers the fact that some accounts classified as current assets are less liquid than others. As a case in point, current assets often include slow-moving inventory items and other items which are not very liquid.

Formula and Calculation for the Current Ratio

This makes it a strict measure of how ready a company is to handle its immediate debts without selling off inventory. The current ratio includes all current assets, like inventory and prepaid expenses. In short, the main difference is the quick ratio looks at how well a company can pay off its short-term debts with its most liquid assets, leaving out inventory and prepaid expenses. The current ratio, however, includes all current assets, giving a fuller picture of the company’s short-term financial health.

The current ratio, also known as the working capital ratio, provides a quick view of a company’s financial health. A strong current ratio greater than 1.0 indicates that a company has enough short-term assets on hand to liquidate to cover all short-term liabilities if necessary. However, a company may have much of these assets tied up in assets like inventory that may be difficult to move quickly without pricing discounts. For this reason, companies may strive to keep its quick ratio between 0.1 and 0.25, though a quick ratio that is too high means a company may be inefficiently holding too much cash. If a company has a current ratio of less than one, it has fewer current assets than current liabilities.

1. The quick ratio helps you track your liquidity, which is your ability to pay bills in the short term.
2. The Quick Ratio, or Acid-test Ratio, focuses more on what can quickly be turned into cash.
3. The quick ratio does not consider most of a company’s current assets.
4. Its computation is similar to that of the current ratio, only that inventories and prepayments are excluded.

The quick ratio formula is quick assets divided by current liabilities. It’s also known as the acid-test ratio and is worth learning—no matter your industry. The quick ratio helps you track your liquidity, which is your ability to pay bills in the short term. Using the quick ratio can help you avoid cash flow problems and maintain good relationships with your creditors and suppliers.

When should you use the quick ratio?

Changes in the current ratio over time can often offer a clearer picture of a company’s finances. A company that seems to have an acceptable current ratio could be trending toward a situation in which it will struggle to pay its bills. Conversely, a company that may appear to be struggling now could be making good progress toward a healthier current ratio.

What is the quick ratio rule of thumb?

But if assets fall without a similar drop in liabilities, the ratios drop. If all current liabilities of Apple had been immediately due at the end of 2021, the company could have paid all of its bills without leveraging long-term assets. In this example, the trend for Company B is negative, meaning the current ratio is decreasing over time. An analyst or investor seeing these numbers would need to investigate further to see what is causing the negative trend. It could be a sign that the company is taking on too much debt or that its cash balance is being depleted, either of which could be a solvency issue if the trend worsens. Public companies don’t report their current ratio, though all the information needed to calculate the ratio is contained in the company’s financial statements.

You can spend less time running the numbers and more time driving success. Since the current ratio compares a company’s current assets to its current liabilities, the required inputs can be quick assets divided by current liabilities is current ratio found on the balance sheet. Liquidity ratios like the quick ratio and current ratio help us understand a company’s liquidity and how easy it can solve immediate debt issues.

While the quick ratio uses quick assets, the current ratio uses current assets. The current ratio formula is current assets divided by current liabilities. This measures the proportion of short-term liquidity compared to current liabilities. The difference between this and the current ratio is in the numerator where the asset side includes only cash, marketable securities, and receivables.

This difference changes how we see a company’s ability to deal with short-term financial needs. What counts as a good current ratio will depend on the company’s industry and historical performance. Current ratios over 1.00 indicate that a company’s current assets are greater than its current liabilities, meaning it could more easily pay of short-term debts. A current ratio of 1.50 or greater would generally indicate ample liquidity. A healthy business has working capital and the ability to pay its short-term bills. A current ratio of more than one indicates that a company has enough current assets to cover bills that are coming due within a year.

The ideal liquidity ratio for your small business will balance a comfortable cash reserve with efficient working capital. A very high quick ratio, such as three or above, is not always a good thing. Note the growing A/R balance and inventory balance require further diligence, as the A/R growth could be from the inability to collect cash payments from credit sales.

How do quick and current ratios apply in different industries?

Less formal reports (i.e., not required by GAAP external reporting rules) may simply report current assets without further breaking down balances. In these situations, it may not be possible to calculate the quick ratio. Both ratios include accounts receivable, but some receivables might not be able to be liquidated very quickly. As a result, even the quick ratio may not give an accurate representation of liquidity if the receivables are not easily collected and converted to cash. A major component of quick assets for most companies is their accounts receivable. If a business sells products and services to other large businesses, it’s likely to have a large number of accounts receivable.

It is calculated by dividing current assets that can be converted into cash in one year, by all current liabilities. If a company reports an acid test ratio of 1, this indicates that its quick assets equal its existing liabilities. A ratio higher than 1 indicates that the company’s quick assets are more than sufficient to cover liabilities. The company is fully capable of paying current liabilities without tapping into its long-term assets and will still have cash or cash equivalents left over. Choosing between the quick ratio or current ratio depends on the industry and personal risk tolerance.

This is why it is helpful to compare a company’s current ratio to those of similarly-sized businesses within the same industry. The current ratio measures a company’s ability to pay current, or short-term, liabilities (debts and payables) with its current, or short-term, assets, such as cash, inventory, and receivables. The current ratio is called current because, unlike some other liquidity ratios, it incorporates all current assets and current liabilities.

Thus, the quick ratio attempts to measure the firm’s immediate debt-paying ability. Quick assets for this purpose include cash, marketable securities, and good debtors only. In other words, prepaid expenses and inventories are not included in quick assets because there may be doubts about the quick liquidity of inventory. The quick ratio counts cash, cash-like assets, and investments that can quickly turn into cash. It includes net accounts receivable but not inventory or pre-paid expenses. A ratio under 1.00 indicates that the company’s debts due in a year or less are greater than its cash or other short-term assets expected to be converted to cash within a year or less.