Current vs Quick Ratio, what are they and why do they matter?

Profitable companies fail all the time. How does this happen? Cash runs dry. You might be turning a profit, but if you do not have Cash to pay the bills on time it all falls apart.

One of the easiest ways to measure the ability of a company to meet its short-term obligations are the use of liquidity ratios. Two of the most common liquidity ratios are the Current ratio and the Quick ratio.

The Current ratio is extremely easy to measure as the information you need should already be easily categorized on your Balance Sheet. Simply take your Current Assets/Current Liabilities=Current Ratio. Current Assets include Cash, securities, accounts receivable, inventory, and assets that can be converted to cash within one year. Current liabilities include accounts payable, short-term debt, and other obligations that are due within one year.

What about the Quick ratio? Take the same equation but on the Current Assets side pull out the Inventory. A company where Current Assets are dominated by Inventory, will see a much harsher reality when using the quick ratio as compared to the current ratio.

What ratio should I use? This depends on the proportion of your Current Assets that are in Inventory, as well as the time in take to turn you Inventory. Industries with quicky inventory turn times such as a restaurant might prefer to use a current ratio, whereas a manufacturer that has long inventory turn times might use a quick ratio as selling through inventory in time is not always a reliable option.

Can I use both? Many companies may use both liquidity ratios at the same time but for different purposes. Some uses of the Current ratio might be budgeting and forecasting, capital and debt management, investment analysis, and capital expenditure planning. Some uses of the Quick ratio might be on Bank loan applications, cash forecasting, contract bidding, as well as through the mergers & acquisitions process.