Current and quick ratios
Also known as: working capital ratios, acid-test ratio
The current and quick ratios are liquidity measures that compare a company's short-term assets to its short-term liabilities. The current ratio uses all current assets, while the quick ratio strips out inventory for a stricter test.
The current and quick ratios are the two standard tools of liquidity analysis — measuring whether a company can cover its bills due within the next year. The current ratio is current assets divided by current liabilities. A ratio above 1 means the company has more short-term resources than short-term obligations; a ratio of 2, for example, means $2 of current assets backs every $1 of current liabilities.
The quick ratio, also called the acid-test ratio, applies a tougher standard by removing inventory from the numerator: (current assets − inventory) ÷ current liabilities. Inventory is excluded because it is the least liquid current asset — it must first be sold, possibly at a discount, before it becomes cash. A company with a current ratio of 2.0 but a quick ratio of 0.8 relies heavily on selling inventory to pay its bills.
Comparing the two ratios reveals the character of a company's balance sheet. Retailers and manufacturers naturally carry large inventories and show a wide gap between the ratios, while service firms often show nearly identical figures. Analysts also track both ratios over time: a steadily declining current ratio can flag a deteriorating working capital position before it becomes a cash crisis.
The Series 7 exam covers the current and quick ratios in its fundamental analysis material. Be ready to compute both from a simple balance sheet, recognize that the quick ratio excludes inventory, and identify which ratio provides the more conservative view of liquidity.
Key takeaways
- The current ratio is current assets divided by current liabilities and gauges short-term solvency.
- The quick (acid-test) ratio excludes inventory from current assets for a stricter liquidity test.
- The quick ratio is never less conservative than the current ratio, and the two are equal only when a company carries no inventory.
- A large gap between the ratios signals heavy reliance on inventory to meet obligations.
- The Series 7 exam tests calculating both ratios and knowing what each includes.