Both seem to measure if a company can pay its short-term debts. Why do we calculate two separate ratios and which one is stricter?
Both are liquidity ratios but the quick ratio is stricter. The current ratio is Current Assets divided by Current Liabilities, and the ideal is 2:1. It includes all current assets such as inventory and prepaid expenses. The quick ratio (also called liquid or acid-test ratio) is Quick Assets divided by Current Liabilities, with an ideal of 1:1. Quick assets exclude inventory and prepaid expenses because these cannot be converted to cash quickly. So the quick ratio tests whether a firm can meet immediate liabilities without selling stock. For example, with current assets of 4,00,000 (including stock of 1,50,000) and current liabilities of 2,00,000, the current ratio is 2:1 but the quick ratio is (4,00,000 minus 1,50,000) / 2,00,000 = 1.25:1. The quick ratio gives a more conservative picture of short-term solvency.
Sign in as a tutor to answer this doubt.