Quick Ratio vs. Current Ratio: An Overview
Both the quick ratio and current ratio measure a company’s short-termliquidity,or itsability to generate enough cash to pay off all debts should they become due at once. Although they’re both measures of a company’s financial health, they’re slightly different. The quick ratio is considered more conservative than the current ratio because its calculation factors in fewer items.
Here’s a look at both ratios, how to calculate them, and their key differences.
Key Takeaways
- The quick and current ratios are liquidity ratios that help investors and analysts gauge a company’s ability to meet its short-term obligations.
- The quick ratio divides cash and cash equivalents by current liabilities.
- The current ratio divides current assets by current liabilities.
- The quick ratio only considers highly liquid assets or cash equivalents as part of current assets, making it a more conservative approach to gauging liquidity.
- The current ratio includes accounts like inventory and accounts receivable, which may be difficult to quickly liquidate or receive (without a discount).
Quick Ratio
The quick ratiomeasures the liquidity of a company by measuring how wellits current assets could coverits current liabilities. Current assetson a company’sbalance sheet representthe value of all assets that can reasonably be converted into cash within one year.
The quick ratio is a more conservativemeasure of liquidity than the current ratio, because it doesn’t include all of the items usedin the currentratio. The quick ratio, often referred to as the acid-test ratio, includesonly assetsthat can be converted to cash within90 days or less.
Current assetsused in the quick ratio include:
- Cash and cash equivalents
- Marketable securities
- Accounts receivable
Current liabilitiesare the company’s debts or obligations on its balance sheet that are due within one year. Examples of current liabilities include:
- Short-term debt
- Accounts payable
- Accrued liabilities andother debts
Quick Ratio Formula
The quick ratio is calculated by adding cash and equivalents, marketable investments, and accounts receivable, and dividing that sum by current liabilities as shown in the formula below:
QuickRatio=CurrentLiabilitiesCash+CashEquivalents+CurrentReceivables+Short-TermInvestments
If a company’s financialsdon’tprovide abreakdown of its quick assets, you can still calculate the quick ratio. You can subtractinventoryand current prepaid assets from current assets, and dividethat differenceby current liabilities.
A company that has a quick ratio of more than one is usually considered less of a financial risk than a company that has a quick ratio of less than one.
A company’s current ratio will often be higher than its quick ratio, as companies often use capital to invest in inventory or prepaid assets.
Current Ratio
The current ratiomeasures a company’sability to paycurrent, or short-term, liabilities (debt and payables) with its current, or short-term, assets (cash, inventory, and receivables).
Examples of a company’scurrent assets include:
- Cash and cash equivalents
- Marketable securities
- Accounts receivable
- Prepaid expenses
- Inventory
Current liabilitiesused in the current ratio are the same as the ones used in the quick ratio:
- Short-term debt
- Accounts payable
- Accrued liabilities andother debts
Current Ratio Formula
You can calculate the current ratio of a company by dividing its current assets by current liabilities,as shown in the formula below:
CurrentRatio=CurrentLiabilitiesCurrentAssets
If a company has a current ratio ofless than one, it has fewer current assets than current liabilities. Creditors would consider the company a financial risk because it might not beable to easily pay down its short-term obligations. If a company has a current ratio ofmore than one, it is considered less of a risk because it could liquidate its current assets more easily to pay down short-term liabilities.
The current ratio will usually be easier to calculate because both the current assets and current liabilities amounts are typically broken out on external financial statements.
Key Differences
The quick ratio offers a more conservative view of acompany’s liquidity or ability to meetit* short-term liabilities with its short-term assets because it doesn’tinclude inventory and other current assets that are more difficult to liquidate (i.e., turn into cash). By excluding inventory,and other less liquid assets,the quick ratio focuses on the company’s more liquid assets.
Both ratios includeaccounts receivable, but some receivables might not be able to be liquidated very quickly. As a result, even the quick ratio may not givean accurate representation of liquidity if the receivables are not easily collected and converted to cash.
Current Ratio
Includes more general ledger accounts
Includes all of the current assets, even those with less liquidity
Is more likely to overstate a company’s liquidity
Includes cash, prepaids, accounts receivable, inventory, and other current assets
Quick Ratio
Includes fewer general ledger accounts
Includes only the most liquid current assets
Is more likely to understate a company’s liquidity
Includes cash and accounts receivable
When Should You Use the Quick Ratio or the Current Ratio?
The quick ratio is a more appropriate metric to use when working or analyzing a shorter time frame. Consider a company with $1 million of current assets, 85% of which is tied up in inventory. If the company has 30 days to liquidate its assets to pay material current liabilities, the company may have to discount inventory to sell it, deteriorating its financial position and overstating its liquidity should the current ratio have been used.
The quick ratio may also be more appropriate for industries where inventory faces obsolescence. In fast-moving industries, a company’s warehouse of goods may quickly lose demand with consumers. In these cases, the company may not have had the chance to reduce the value of its inventory via a write-off, overstating what it thinks it may receive due to outdated market expectations.
The current ratio is better in a few different scenarios. Most often, companies may not face imminent capital constraints, or they may be able to raise investment funds to meet certain requirements without having to tap operational funds. Therefore, the current ratio may more reasonably demonstrate what resources are available over the subsequent year compared to the upcoming 12 months of liabilities.
The current ratio may also be easier to calculate based on the format of the balance sheet presented. 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.
Special Considerations
Since the current ratio includes inventory, it willbe high forcompanies that areheavily involved in selling inventory. For example, inthe retail industry, a store might stock up on merchandise leading up to the holidays, boosting itscurrent ratio. However, when the season is over, the current ratio would come down substantially. As a result, the current ratio would fluctuate throughout the year for retailers and similar types of companies.
On the other hand, removinginventory might not reflect an accurate picture of liquidityfor some industries.For example, supermarketsmove inventory very quickly, and their stock wouldlikely represent a large portion of their current assets. To strip out inventory for supermarkets would make their current liabilities look inflated relative to their current assets under the quick ratio.
Real-World Example of Current Ratio and Quick Ratio
Consider the Jan. 31, 2022 balance sheet for Walmart Inc., shown below as part of its 2022 annual report. Relevant information for analysis includes:
- Cash and cash equivalents: $14,760 (2022), $17,741 (2021)
- Receivables (net): $8,280 (2022), $6,516 (2021)
- Total current assets: $81,070 (2022), $90,067 (2021)
- Total current liabilities: $87,379 (2022), $92,645 (2021)
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Based on the figures called out above, Walmart’s current ratios and quick ratios for 2021 and 2022 (for the reporting period as of the balance sheet above) were:
- Current ratio (2022): $81,070 ÷ $87,379 = 0.928
- Current ratio (2021): $90,067 ÷ $92,645 = 0.972
- Quick ratio (2022): $14,760 + $8,280 ÷ $87,379 = 0.264
- Quick ratio (2021): $17,741 + $6,516 ÷ $92,645 = 0.262
From this information, a few conclusions can be drawn. Walmart’s short-term liquidity worsened from 2021 to 2022, though it appears to have almost enough current assets to pay off current debts. A wide majority of current assets are not tied up in cash, as the quick ratio is substantially less than the current ratio. In addition, though its quick ratio only dropped a little, there are bigger changes in cash on hand vs. the balances in accounts receivable.
Why Is the Quick Ratio Better than the Current Ratio?
Some may consider the quick ratio better than the current ratio because it is more conservative. The quick ratio demonstrates the immediate amount of money a company has to pay its current bills. The current ratio may overstate a company’s ability to cover short-term liabilities as a company may find difficulty in quickly liquidating all inventory, for example.
What Are the Limitations of the Quick Ratio?
The quick ratio does not consider most of a company’s current assets. It may be unfair to discount these resources, as a company may try to efficiently utilize its capital by tying money up in inventory to generate sales. However, only the money in the most liquid form is considered.
What Are the Limitations of the Current Ratio?
The current ratio does not inform companies of items that may be difficult to liquidate. 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.
What Is Considered a Good Quick Ratio and a Good Current Ratio?
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.
The Bottom Line
When analyzing a company’sliquidity, no single ratio will sufficein every circ*mstance. It’s important to include other financial ratios in your analysis, including boththe current ratio and the quick ratio, as well as others. More importantly, it’s critical to understand what areas of a company’s financials the ratios are excluding or including to understand what the ratio is telling you.
Correction—April 30, 2023: An earlier version of this article contained an arithmetic error in the calculation of Walmart’s quick ratio for 2021. It has been corrected to show that the quick ratio for that year was 0.262.
