Current Ratio – Formula, Meaning, Assumptions and Interpretations
The current ratio is the most popularly used metric to gauge the short term solvency of a company. This article provides the details about this ratio. Formula Current Ratio = Current Assets / Current Liabilities Meaning Current ratio measures the current assets of the company in comparison to its current liabilities. This means that the…
What are Common Size Statements ?
Common size statements are not financial ratios. Rather they are a way of presenting financial statements that makes them more suitable for analysis. However, analysts always use them in conjunction with ratio analysis. In fact, financial analysts use common size statements as the starting point to help them dig deeper. Common size statements tell them…
Introduction to Cash Flow Ratios
Once upon a time, investors and analysts used to believe in ratios that have been calculated based on the earnings that the company has stated in the Income Statement. Alas! That was once upon a time. Of late, there have been a huge number of frauds and malpractices that have come to the fore. All…
The quick ratio is a variation of the current ratio. However, a quick ratio is considered by many to be a more conservative estimate than the current ratio. This characteristic fetches it the nickname of being the “Acid test ratio”.
The difference between the current ratio and the quick ratio is the fact that quick ratio excludes the inventory. In theory this may seem like a small difference, however in practice anyone who is aware about the difficulties involved in liquidating inventories at the right price will vouch for the conservativeness of this ratio. The quick ratio has been discussed in greater detail in this article.
Quick Ratio = (Current Assets - Inventories) / Current Liabilities
The quick ratio checks the company’s performance to fulfill its obligations in a situation when it is not able to liquidate its inventory. In such a situation the company will have to pay its current liabilities out of the cash and cash equivalents that it has on hand and the amount of money it has already tied up in accounts receivables. The ideal quick ratio is considered to be 1:1. However, this varies widely according to the different credit cycles prevalent if different industries. Hence an analyst must look at competing firms and the industry average before forming opinions based on the current ratio.
There are no assumptions made regarding the inventory, because it is excluded from the calculation of this ratio. However, there are assumptions made about debtors and the fact that they will pay up on time to finance the payment of short term liabilities that a company has on hand.
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