Current & Quick Ratios

\text{Current} = \frac{CA}{CL} \qquad \text{Quick} = \frac{CA - \text{Inventory}}{CL}

$CA$: current assets: cash, receivables, inventory — everything expected to become cash within a year
$CL$: current liabilities: payables, short-term debt — everything demanding cash within a year
$CA - \text{Inventory}$: the 'quick' assets: only the near-cash items a skeptic would count
$\frac{CA}{CL} > 1$: a ratio above 1 means the year's resources cover the year's claims

Why it must be true

Liquidity ratios answer the bluntest question in credit analysis: if the bills due this year all arrived, could the company pay them? The current ratio lines up everything that will turn into cash within a year (current assets) against everything that will demand cash within a year (current liabilities). Above 1, the year's resources cover the year's claims.

The quick ratio is the same question asked by a skeptic: inventory is the current asset you cannot count on — it must first be sold, at an uncertain price, on an uncertain date. Strip it out and the ratio tests whether near-cash alone covers the bills. A wide gap between the two ratios is itself a finding: the company's liquidity is parked in warehouses.

The derivation

Both ratios come from the same balance-sheet identity, read over a one-year horizon. Sources of near-term cash over uses of near-term cash:

\text{Current ratio} = \frac{CA}{CL}

Now rank current assets by how surely they become cash: cash itself, then receivables (someone owes you), then inventory (someone must be persuaded to owe you). Deleting the weakest link gives the stress-test version:

\text{Quick ratio} = \frac{CA - \text{Inventory}}{CL}

By construction Quick ≤ Current, and the difference is exactly the inventory reliance.

When to reach for it

Assessing short-term solvency from a balance sheet — can the company meet obligations due within the year, with or without relying on selling inventory.

Listen for

“ability to meet short-term obligations”“current assets … current liabilities”“excluding inventory / most conservative liquidity measure”“working capital position”

Back-of-the-envelope

Estimate it in your head first — then the calculator only confirms.

≈
Quick ≤ Current, always — inventory can only be subtracted. If a computed quick ratio exceeds the current ratio, a number went in the wrong slot.
≈
Round to lead digits: CA 480 / CL 310 → 48/31 ≈ 1.5. Ratio questions rarely need more than two significant figures to pick the right choice.
≈
A big Current-minus-Quick gap flags inventory-heavy liquidity — retailers and manufacturers live there; software firms should show almost none.

Traps in applying it

✗Including long-term assets or debt — both ratios are strictly the within-one-year slices of the balance sheet.
✗Forgetting to subtract inventory for the quick ratio (or subtracting it from the wrong side).
✗Reading a high current ratio as pure strength: it can mean bloated inventory or uncollected receivables — efficiency ratios tell the other half.

Limits & criticisms

A snapshot, not a movie: the ratio is measured on one balance-sheet date and can be window-dressed (pay down payables just before quarter-end and the ratio improves with no real change in health). It also treats all current assets at book value — receivables that won't collect and inventory that won't sell pass the current ratio right up until they don't. Cash-flow measures catch what it misses.

Where it came from

Liquidity ratios are among the oldest tools in credit analysis — 19th-century bank lending manuals already demanded a "two-to-one rule" (current assets twice current liabilities) before extending trade credit, decades before formal security analysis existed. Graham and Dodd's Security Analysis (1934) canonized them, and today they gate loan covenants, supplier credit terms and working-capital dashboards: a covenant breach on the current ratio is often the first legal tripwire in a corporate deterioration.

One identity, 2 questions

The exam can hide any variable. Each face below is the same equation solved for a different unknown — drill them separately.

Current ratio

\text{Current} = \frac{CA}{CL}

The trusting version: counts every current asset, inventory included, as good for the bills.

Drill this face →

Quick ratio (acid test)

\text{Quick} = \frac{CA - \text{Inventory}}{CL}

The skeptic's version: only near-cash counts. The gap to the current ratio measures inventory reliance.

Drill this face →

On the BA II Plus

Worked example: From the balance sheet: current assets $620.00m, of which inventory $70.00m; current liabilities $330.00m. Compute the quick (acid-test) ratio.

1.620 [−] 70 [=]strip out inventory
2.[÷] 330 [=]over current liabilities

→ 1.6667

Where it leads

Master this and the following come almost for free:

Cash Conversion Cycle

Drill this formula Back to the library