Current ratio and quick ratio are terms used in the context of accountancy and both measure company’s ability to repay its short-term obligations as and when they become due. In short both the ratios measures company’s short-term liquidity position, however, they both are not the same and there are many differences between the two. Let’s look at some of the differences between the current ratio and quick ratio –
Current Ratio VS Quick Ratio
Meaning and Formula
Current Ratio is a liquidity ratio that measures the company’s ability to pay its short term liabilities and the formula is Current Assets/ Current Liabilities while quick ratio refers to that liquidity ratio that measures the company’s ability to pay its current liabilities from near cash assets and formula for quick ratio is Quick Assets/ Current Liabilities.
Example
An example of Current ratio is suppose cash balance is $30000, sundry debtors are $30000 closing stock is $30000 and prepaid expense is $10000 than total current assets of the company are $100000. Now suppose sundry creditors are $20000, bills payables are $30000 than total current liabilities of the company are $50000 then the current ratio of the company will be $100000/$50000 = 2:1. An example of the quick ratio is when we take into account only cash balance of $30000 and sundry debtor’s balance of $30000 which results in company’s quick assets being $60000 and current liabilities will remain $50000 now quick ratio will be $60000/$50000 = 1.2:1.
Closing Stock and Prepaid Expense
In the case of current ratio, both closing stock as well as prepaid expenses are part of current assets and hence are included while calculation of current ratio but when it comes to quick ratio both closing stock as well as prepaid expense is not included in quick assets and hence both are excluded while calculation of the quick ratio.
Higher and Lower
The current ratio will always be higher than the quick ratio because closing stock and prepaid expenses are excluded from the numerator side in case of a quick ratio. In simple words due to current assets being higher than quick assets or liquid assets current ratio will always be higher than the quick ratio.
When it is Used
The current ratio is used when the company wants to know its liquidity position while the quick ratio is used when the company wants to know the near-cash position of the business because in the case of industries where the stock requirement is high then the current ratio will be way higher than quick ratio and if the company is in need of cash than higher current ratio is of no use due to higher stock component and the company can be in liquidity crisis even current ratio is high.
Ideal Ratio
In the case of current ratio ideal ratio is 2:1 that is for every 1 dollar of current liability the company needs to have 2 dollars of current assets, while in the case of quick ratio ideal ratio is 1:1 that is for every 1 dollar of current liability the company needs to have 1 dollar of quick assets.
As one can see from the above that there are many differences between current ratio and quick ratio and that is the reason why anyone analyzing current or quick ratio should keep the differences in mind before making any decision about the liquidity position of the company on the basis of these ratios.