Question

How does the current ratio compare to the quick ratio?

Answer 1

Current ratio and quick ratios are referred to as liquidity ratios. These ratios are used to determine whether a company will be able to pay off its short term debt obligations.

Current ratio:
Current ratio is the ratio of liquid current assets to current liabilities.
Current ratio=(Current assets)/(Current liabilities)
The common items that comes under current assets are cash and cash equivalents, inventory, prepaid expenses, accounts receivables etc
The common items that comes under current liabilities are accounts payable, short term notes payable, wages payable etc
Current liabilities refers to the liabilities that needs to paid off within a year.
A current ratio of 2:1 is considered as ideal ratio.
Current ratio can be used to analyse the financial position of a company and take corrective measures to check if the company will be able to pay off its short term debt (and dues) on time.
Current ratio cannot be used to compare various industries, it can only be used to compare similar companies

Quick ratio:
Quick ratio is also called as acid test ratio.
Quick ratio=(Current assets - Inventories - Prepayments)/Current liabilities
It provides more reliable information on the industry which is seasonal by nature.
It ignores the timing and the levels of the cash flows.
As the ratio does not contain inventory, it is not required to value the inventory of the firm.