3.1.3. Current and Quick Ratios
The current ratio, also known as the working capital ratio, measures a company’s ability to pay short-term obligations using short-term assets. The ratio is expressed as follows:
A high current ratio suggests that the company has no liquidity issues and is likely able to pay its debts over the next year as they come due. A current ratio that is close to or below 1.0 may be a danger signal that the company could experience difficulty meeting its obligations. Typical and acceptable current ratios vary from industry to industry, and a low current ratio does not necessarily indicate that a company is experiencing financial distress. An abnormally high current ratio might suggest that the company is not managing its current assets efficiently.
Example: The Astral Planing Company’s balance sheet shows current assets of $1.4 million and current liabilities of $700,000. Astral’s current ratio is a presumably comfortable 2.0 ($1,400,000 / $700,000).
Example: Faceplant Unicycles Inc. has current assets of $120,000 and current liabilities of $150,000. Its current ratio is a sobering 0.8 ($120,000 / $150,000). Faceplant could have problems if all its liabilities came due at once.
The quick ratio, also known as the acid-test ratio or quick asset ratio, is another widely used measure of a company’s ability to pay its short-term obligations. This ratio is similar to the current ratio, but it excludes inventories from current assets and focuses instead on the company’s most liquid assets. The quick ratio is somewhat more conservative than the current ratio, because it analyzes what wo