Quick ratio vs current ratio differences and similarities

Quick ratio vs current ratio differences, What are their uses?

Investors and analysts compare the quick ratio vs current ratio to gauge a company’s ability to meet its short-term obligations. Even though the quick ratio and current ratio are both liquidity ratios that measure the short-term liquidity of a company, they are calculated differently. These ratios evaluate the ability of the company to generate enough cash to pay off all debts should the debts become due at once.

The quick ratio and current ratio are slightly different. Among these two ratios, the quick ratio is known to be more conservative than the current ratio because it features fewer items in its calculation. The current ratio divides all current assets by current liabilities whereas, the quick ratio doesn’t consider all current assets, it only considers highly-liquid assets or cash equivalents as part of current assets.

Here’s a look at quick ratio vs current ratio differences, how they are calculated, and their similarities.

The quick ratio vs current ratio differences is based on the inclusion or exclusion of less liquid assets in the calculation
The quick ratio vs current ratio differences is based on the
inclusion or exclusion of less liquid assets in the calculation

What are the quick ratio and current ratio?

The quick ratio is a type of liquidity ratio that evaluates the company’s ability to meet its short-term liabilities with its most liquid assets or near cash. Whereas, the current ratio is a type of liquidity ratio that measures the company’s ability to pay its short-term or current liabilities with its short-term or current assets.

Let’s compare the meaning of the current ratio vs quick ratio.

Quick ratio

The quick ratio also known as the acid-test ratio is a type of liquidity ratio that evaluates the company’s ability to meet its short-term liabilities with its most liquid assets or near cash. The term ‘acid test’ is slang for a quick test created to produce instant results. This ratio is called a quick ratio because it indicates the ability of the company to immediately use its assets that can be converted quickly to cash (near-cash assets) to settle its current liabilities.

The acid test ratio is the ratio between liquid assets or quickly available assets and current liabilities. This ratio only looks at the most liquid assets that the company has to settle its short-term debts and obligations. The liquid or quick assets of the company are the current assets that can apparently be quickly converted to cash at close to the book value of the company. The quick ratio simply evaluates whether a company has enough liquid assets that can be converted into cash to take care of its bills. In the quick ratio, the key component of liquid assets that are included are cash, cash equivalent, marketable securities, and accounts receivable.

Current ratio

The current ratio also known as the working capital ratio is a type of liquidity ratio that measures the company’s ability to pay its short-term or current liabilities with its short-term or current assets. This ratio evaluates how a business can maximize the current assets on its balance sheet to pay off its current debt and other payables.

The ratio simply measures the short-term liquidity of a company with respect to its available assets. It evaluates the ability of a company to use its short-term or current assets, such as cash, cash equivalent, inventory, marketable securities, accounts receivable, and other current assets (OCA) to settle its current or short-term debts and payables.

Quick ratio vs current ratio interpretation

Since there is a difference in how the quick ratio vs current ratio calculation is done, their interpretation would definitely vary. A quick ratio analysis would indicate whether a company has enough liquid assets that can be converted into cash within 90 days or less to settle its current liabilities. The current ratio analysis, on the other hand, would compare the company’s current assets to its current liabilities, thus, indicating whether a company has enough resources to settle its short-term obligations.

The quick ratio interpretation tells us the number of current assets that the company can quickly convert into cash with minimal impact on the price received in the open market relative to the amount of the debts and obligations of the company that is due to be paid to creditors within one year. Whereas, the interpretation of the current ratio tells us the number of all current assets available in the company against the amount of the debts and obligations of the company that is due to be paid to creditors within one year.

Whether the quick and current ratio of a company is bad or good may depend on several factors such as industry average, growth, risk, economic conditions, accounts receivable, and inventories (the business may have a kind of inventory that was easy to quickly convert to cash). However, these are some of the interpretations from the calculation of these ratios:

  • A quick ratio that is 1 is considered to be ideal, indicating that the company has the needed liquid assets to settle its current liabilities. Likewise, a current ratio that is equal to 1 indicates that the current assets of the company equate to its current liabilities, meaning that the company has just enough current assets to settle short-term obligations.
  • A quick ratio of less than 1 can be interpreted that the business may not be capable of fully paying off its current liabilities in the short term. Similarly, a current ratio of less than 1 shows that the company’s current assets are less than its current liabilities. This could be an indication that the company do not have enough current assets to settle its short-term obligations.
  • A business with a quick ratio greater than 1 can be interpreted that the business can immediately settle its current liabilities. Likewise, a current ratio greater than 1 shows that the current assets of the company are greater than its liabilities and can be seen as a desirable situation for investors and creditors.

Quick ratio vs current ratio differences

  1. The main difference between the quick vs current ratio is that the current ratio is centered on all the current assets whereas the quick ratio is centered on only assets that can be quickly converted to cash.
  2. There is a difference in the quick ratio vs current ratio formula. The current ratio is calculated by dividing the current assets of the company by the current liabilities. The quick ratio, on the other hand, is calculated by dividing the most liquid assets by the current liabilities.
  3. The current assets in the current ratio include all the prepaid expenses, inventory, cash and cash equivalents, etc that can be accounted for in the current year. Whereas, the current assets in the quick ratio are calculated by excluding inventory and prepaid expenses because these assets are not easy to quickly convert into cash.
  4. The current ratio is also known as the working capital ratio whereas, the quick ratio is also known as the acid test ratio.

The table below summarizes the major current vs quick ratio differences:

CriteriaQuick ratioCurrent ratio
DefinitionThe quick ratio is a type of liquidity ratio that evaluates the company’s ability to meet its short-term liabilities with its most liquid assets or near cashThe current ratio is a type of liquidity ratio that measures the company’s ability to pay its short-term or current liabilities with its short-term or current assets
Also known asAcid test ratioWorking capital ratio
When it is usedIt is useful for determining the company’s ability to meet its urgent debts and obligation with its liquid assetsIt is useful for determining the company’s ability to meet its current debts and obligations
FormulaQuick ratio= Liquid assets / Current liabilities
Current ratio = Current Assets / Current Liabilities
The current assets includeCash and cash equivalent + Marketable securities + Accounts receivableCash and cash equivalent + Marketable securities + Accounts receivable + Inventory + Prepaid expenses
LimitationsThe ratio doesn’t give any indication of the future cash flow activity of a company. There are also considerations to make in the quick ratio formula in regard to the true liquidity of accounts receivable and marketable securities in some situations.The current ratio is not as helpful as the quick ratio in determining liquidity because it lacks specificity. It includes all the assets that may not be easily liquidated such as inventory and prepaid expenses. The ratio can also be manipulated by management.
Quick ratio vs current ratio differences

Quick ratio vs current ratio formula

Let’s look at the quick ratio vs current ratio formula

The formula for a quick ratio

The quick ratio can be expressed as:

Quick ratio= Liquid assets / Current liabilities

or

Quick ratio= (Cash and cash equivalent + Marketable securities + Accounts receivable) / Current liabilities

or

Quick ratio= (Current assets – Inventory – Prepaid expenses) / Current liabilities

The formula for a current ratio

The current ratio can be expressed as:

Current ratio = Current Assets / Current Liabilities

Where,

Current assets= Cash and cash equivalent + Marketable securities + Accounts receivable + Inventory + Prepaid expenses + other current assets (OCA)

Differences in the current and quick ratio calculation

Wondering when to use quick ratio vs current ratio calculation? The quick ratio is a more conservative method than the current ratio when comparing the quick ratio vs current ratio. Calculating the quick ratio is a better method when considering the ability of the company to settle its debt in the next 90 days. Whereas, the current ratio calculation is a better method to use when considering the longer view of liquidity.

The current assets and current liabilities used for the calculation of the quick and current ratio are listed on the company’s balance sheet. The current assets include items such as accounts receivable, cash, inventory, and other current assets (OCA) that are expected to be liquidated or turned into cash within a year. While, the current liabilities include short-term debts, wages, accounts payable, taxes payable, and the current portion of long-term debt.

Example 1

Company ABC and Company XYZ are two leading competitors operating in the food industry.

  1. Calculate the current ratio of Company ABC and Company XYZ based on the figures given in the table below as appeared on their balance sheets for the fiscal year ending in 2021.
  2. Which of these companies is in a more liquid, solvent position?
Balance sheet items Company ABCCompany XYZ
CURRENT ASSETS:
Cash and cash equivalents $30,000$58,000
Accounts receivable $15,000$45,000
Inventories $60,000$2,000
Total current assets $105,000 $105,000
CURRENT LIABILITIES:
Accounts payable $75,000$20,000
Short-term notes payable $40,000 $80,000
Wages payable$15,000$30,000
Total current liabilities $130,000$130,000
Quick ratio vs current ratio differences in calculation example 1

Here is a calculation example to illustrate the quick ratio vs current ratio differences

HOW TO CALCULATE THE CURRENT RATIO USING THE EQUATION:

Current ratio = Current Assets / Current Liabilities

Calculating the current ratio for Company ABC will be:

Current ratio = $105,000 / $130,000 = 0.807

Calculating the current ratio for Company XYZ will be:

Current ratio = $105,000 / $130,000 = 0.807

In the current ratio calculation done for Company ABC and Company XYZ, it is seen that the two companies both have a current ratio value of 0.807 which is less than 1. This indicates that Company ABC and Company XYZ may not have enough current assets to settle their short-term obligations. Since these companies have the same current ratio an investor can look deeper into a detailed comparison of these companies by evaluating other liquidity ratios such as the quick ratio which is more narrowly focused than the current ratio.

In order to know which of these companies is in a more liquid, solvent position, we may have to calculate the quick ratio of both companies.

HOW TO CALCULATE THE QUICK RATIO USING THE EQUATION:

Quick ratio= (Current assets – Inventory – Prepaid expenses) / Current liabilities

Calculating the quick ratio for Company ABC will be:

Quick ratio = ($105,000 – $60,000) / $130,000 = 0.346

Calculating the quick ratio for Company XYZ will be:

Quick ratio = ($105,000 – $2,000) / $130,000 = 0.79

In the quick ratio calculation done for Company ABC and Company XYZ, it is seen that Company ABC has a quick ratio of 0.346 while Company XYZ has a higher quick ratio value of 0.79. As we can see the quick ratio gives us a better insight into the short-term liquidity of these companies. As seen from the calculation, even though these two companies had a similar current ratio of 0.807, Company XYZ is likely in a more liquid and solvent position having a higher quick ratio than Company ABC.

Furthermore, the following observations from the balance sheet prove why Company XYZ is in a more liquid and solvent position than Company ABC:

  • Company XYZ has lesser inventory than Company ABC. Company ABC has much more inventory which may be difficult to turn into cash in the short term. Moreso, there is a probability that this inventory is unwanted or overstocked, which may eventually reduce its value on the balance sheet.
  • The most liquid asset is cash and Company XYZ has more cash than Company ABC.
  • Even though Company ABC has more accounts receivable, which could be collected more quickly than liquidating inventory, Company XYZ is better off with more cash and less inventory.
  • Therefore, based on assets comparison, despite the two companies having the same total value of current assets, Company XYZ is in a more liquid, solvent position.

In addition, even though the current liabilities of Company ABC and Company XYZ amounts to the same value, they are still very different. Company ABC has more accounts payable, whereas Company XYZ has a greater amount in short-term notes payable. There may be a need for further investigation as there is a probability that the accounts payable will have to be paid before the entire balance of the notes-payable account. Furthermore, Company ABC has fewer wages payable, which is the liability most likely to be paid in the short term.

Example 2

Calculate the quick ratio and current ratio of a tech firm with current liabilities of $170,000 and the following balance sheet data:

AssetsAmount
CURRENT ASSETS
Cash on hand$35,000
Cash in bank$25,000
Short-term investments$40,000
Inventory$60,000
Accounts receivable$85,000
Prepaid insurance$15,000
TOTAL CURRENT ASSETS$260,000
NON-CURRENT ASSETS
Fixed assets$90,000
Goodwill$30,000
TOTAL NON-CURRENT ASSETS$120,000
Quick ratio vs current ratio calculation example 2

Solution

HOW TO CALCULATE THE QUICK RATIO USING THE FORMULA:

Quick ratio= (Current assets – Inventory – Prepaid expenses) / Current liabilities

First, let’s solve to get the numerator in the quick ratio formula above:

(Current assets – Inventory – Prepaid expenses)= $260,000 – $60,000 – $15,000= $185,000

Quick ratio= $185,000 / $170,000= 1.08

From the calculation done, the quick ratio of the company is 1.08. This ratio is greater than 1 which indicates that the company has the needed liquid assets to settle its current liabilities.

HOW TO CALCULATE THE CURRENT RATIO USING THE FORMULA:

Current ratio = Current Assets / Current Liabilities

Current ratio= $260,000 / $170,000= 1.52

From the current ratio calculation done, the company has a ratio of 1.52. This ratio is greater than 1 which indicates that the company has the needed current assets to settle its current liabilities.

Current ratio vs quick ratio which is better?

Calculating the quick ratio is a better method when considering the ability of the company to settle its debt in the next 90 days. Whereas, the current ratio calculation is a better method to use when considering the longer view of liquidity.

However, it is important to note that if a business doesn’t have inventory assets, the current and quick ratios are nearly identical as both ratios provide the same results. Moreso, when calculating the liquidity ratio for a business, it is best to calculate more than one ratio. The current ratio and quick ratio will provide a measure of liquidity for the business, though when these ratios are combined with other accounting ratios, it gives a much clearer and deeper insight into the business finances.

In business, calculating accounting ratios such as the current and quick ratios can help the management identify trouble spots and ascertain whether the business is headed in the wrong direction. The results from these ratios can also be helpful when making financial projections for the business.

Similarities

  1. The quick ratio and current ratios are both used to determine the ability of a company in settling its current liabilities with its current assets.
  2. They are both liquidity ratios that measure the short-term liquidity of a company.
  3. The quick ratio and current ratios can both be calculated using current assets and current liabilities on the balance sheets.

Current ratio vs quick ratio vs cash ratio

The quick ratio, current ratio and cash ratio are all kinds of liquidity ratios. However, there is a difference when comparing the current ratio vs quick ratio vs cash ratio. These ratios are calculated differently. The difference between these ratios is that the quick ratio evaluates the company’s ability to settle its short-term liabilities using its most liquid assets while the current ratio measures the company’s ability to pay its short-term or current liabilities with its short-term or current assets. The cash ratio, on the other hand, measures the company’s ability to settle its short-term liabilities using only cash and cash equivalents.

Conclusion

The quick ratio provides a more conservative view of the liquidity of a company and its ability to settle its short-term debts and obligations compared to the current assets. This is because the ratio doesn’t include inventory and other current assets that are more difficult to turn into cash (liquidate). The quick ratio is centered on the company’s most liquid assets when inventory and other less liquid assets are excluded from the equation.

In as much as the current and quick ratio includes accounts receivable in their equation, some receivables may not be able to be liquidated quickly. Therefore, if the receivables are not easily collected and converted to cash, even the quick ratio may not give an accurate representation of liquidity.

Furthermore, since inventory is included in the current ratio, the ratio will be high for companies that are heavily involved in selling inventory. In the retail industry, for instance, a store may stock up on products leading up to the holidays, thus, boosting its current ratio. Nevertheless, the current ratio would come down substantially when the season is over. Due to this, the current ratio would fluctuate throughout the year for retailers and similar types of firms.

Removing inventory as in quick ratio, on the other hand, may not reflect an actual picture of liquidity for some industries. Supermarkets, for instance, move inventory very quickly, and their stock would probably represent a huge portion of their current assets. Therefore, removing inventory for supermarkets under the quick ratio would make their current liabilities look inflated relative to their current assets.

In conclusion, no single ratio will be enough in every circumstance. So, it is best to include other financial ratios in the analysis. The current ratio and the quick ratio should be used along with other financial ratios. Most importantly, it is necessary to understand what part of the company’s financials is excluded or included in the financial ratio used in order to understand what the ratio interprets.

A video explaining the quick ratio vs current ratio differences in calculation
Obotu Agape Oguche