Question

Two common ratios that provide similar information to an enterprise are the Current Ratio and Quick Ratio.

1）What basic information do these ratios provide, that is, which category do these ratios fall into?

2）Suppose a camping product retailer has a liquidity ratio of 2.7. What does this say about the company in general? Suppose the quick ratio of the enterprise is 0.75:1. What does this mean? Is it possible for an enterprise to have a flow and a quick ratio of these two values? Why is that?

Answer 1

Two common ratio that provide similar information about an enterprise are Current ratio and quick ratio:

1) Current ratio and quick ratio both fall into the category of liquidity ratio. Liquidity ratio provides informaton about an enterprise ability to pay short term obligation without raising external cash. It measures margin of safety for the supplier in the short term. The difference between the current ratio and quick ratio is that quick ratio excludes inventory and prepaid assets. So quick ratio is more reliable than current ratio. Current ratio is measured as current assets divided by current liabilities whereas quick ratio is measured as current assets minus inventory and prepaid assets and then divide it by the current liability.

2) If the retailer has a liquidity ratio of 2.7, assuming this is a current ratio, it says that its current assets are 2.7 times it's current liability. Though it seems to be a good number but we need to compare with the industry in general and then we can comment on that.

If the quick ratio of the enterprise is 0.75: 1, it means that a significant part of current asset is in the form of inventory and prepaid assets, normally a quick ratio of 1:1 is said to be good but 0.75 is not very good. The enterprise ability to pay to suppliers in the short term needs to be managed more efficiently. Yes, it is possible for an enterprise to have a different current ratio and quick ratio. It is because of the different methods they are used to calculate. current ratio is simply current assets divided by current liabilities while quick ratio excludes the inventory and prepaid assets from the current assets