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Current Ratio vs. Quick Ratio: What's the Difference?

Current vs. Quick Ratio: An Overview

Both the current ratio and quick ratio measure a company's short-term liquidity, or its ability 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 current ratio divides current assets by current liabilities.
• The quick ratio divides cash and cash equivalents by current liabilities.
• The current ratio includes accounts like inventory and accounts receivable which may be difficult to quickly liquidate or receive (without a discount).
• 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.

Current Ratio

The current ratio measures a company's ability to pay current, or short-term, liabilities (debt and payables) with its current, or short-term, assets (cash, inventory, and receivables).

Current assets on a company's balance sheet represent the value of all assets that can reasonably be converted into cash within one year. Examples of current assets include:

Current liabilities are the company's debts or obligations on its balance sheet that are due within one year. Examples of current liabilities include:

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:

$\text{Current Ratio}= \frac{\text{Current Assets}}{\text{Current Liabilities}}$

If a company has a current ratio of less than one, it has fewer current assets than current liabilities. Creditors would consider the company a financial risk because it might not be able to easily pay down its short-term obligations. If a company has a current ratio of more 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.

Quick Ratio

The quick ratio also measures the liquidity of a company by measuring how well its current assets could cover its current liabilities. However, the quick ratio is a more conservative measure of liquidity because it doesn't include all of the items used in the current ratio. The quick ratio, often referred to as the acid-test ratio, includes only assets that can be converted to cash within 90 days or less.

Current assets used in the quick ratio include:

• Cash and cash equivalents
• Marketable securities
• Accounts receivable

Current liabilities used in the quick ratio are the same as the ones used in the current ratio:

• Short-term debt
• Accounts payable
• Accrued liabilities and other 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:

\begin{aligned} \text{Quick Ratio}= \frac{ \begin{array}{c} \text{Cash}+\text{Cash Equivalents }+\\ \text{Current Receivables}+\text{Short-Term Investments} \end{array} }{\text{Current Liabilities}} \end{aligned}

If a company's financials don't provide a breakdown of its quick assets, you can still calculate the quick ratio. You can subtract inventory and current prepaid assets from current assets, and divide that difference by current liabilities.

Similar to the current ratio, 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.

Key Differences

The quick ratio offers a more conservative view of a company’s liquidity or ability to meet its short-term liabilities with its short-term assets because it doesn't include 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 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.

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

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 situation, it may not be possible to calculate the quick ratio. Special Considerations Since the current ratio includes inventory, it will be high for companies that are heavily involved in selling inventory. For example, in the retail industry, a store might stock up on merchandise leading up to the holidays, boosting its current 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, removing inventory might not reflect an accurate picture of liquidity for some industries. For example, supermarkets move inventory very quickly, and their stock would likely 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 Wal-Mart 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) 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 = .927 • Current Ratio (2021):$90,067 / $92,645 = .972 • Quick Ratio (2022):$14,760 + $8,280 /$87,379 = .264
• Quick Ratio (2021): $17,741 +$6,516 / \$82,645 = .293

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 versus 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 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 .1 and .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's liquidity, no single ratio will suffice in every circumstance. It's important to include other financial ratios in your analysis, including both the 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.

Article Sources
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1. Walmart. "2022 Annual Report."