Current Ratio and Quick Ratio Formula, Example & Comparison Table
The difference between current ratio and quick ratio is a crucial concept in accounting and financial management. Both ratios help analyze a company’s ability to pay short-term liabilities, making them important for Class 12 Accountancy exams, commerce students, and real-world business scenarios. Understanding them equips students with essential skills for financial analysis.
| Parameter | Current Ratio | Quick Ratio |
|---|---|---|
| Formula | Current Assets / Current Liabilities | (Current Assets – Inventory – Prepaid Expenses) / Current Liabilities |
| Other Names | Working Capital Ratio | Acid Test Ratio |
| Assets Included | All current assets (cash, receivables, inventory, prepaid expenses, etc.) | Only the most liquid assets (cash, receivables, cash equivalents) |
| Purpose | Measures ability to pay all short-term obligations | Measures ability to meet immediate obligations |
| Significance | Gives an overall view of liquidity | Shows true, instant liquidity position |
Difference Between Current Ratio And Quick Ratio
The primary difference between current ratio and quick ratio is that the current ratio includes all current assets, while the quick ratio only includes assets quickly convertible to cash (excluding inventory and prepaid expenses). Both ratios evaluate a company’s short-term financial strength but differ in how strictly they define liquidity.
What is Current Ratio?
The current ratio is a liquidity ratio that compares a firm’s current assets to its current liabilities. It is also called the working capital ratio. A higher current ratio generally indicates greater liquidity and financial health. This concept is vital for exams and business analysis.
What is Quick Ratio?
The quick ratio, also known as the acid test ratio, evaluates a company’s most liquid assets against its current liabilities. Unlike the current ratio, it excludes inventory and prepaid expenses, focusing on assets that can be instantly converted into cash to pay debts. Quick ratio highlights a firm’s immediate paying capacity.
Formulas of Current Ratio and Quick Ratio
- Current Ratio = Current Assets / Current Liabilities
- Quick Ratio = (Current Assets – Inventory – Prepaid Expenses) / Current Liabilities
| Included in Current Ratio | Included in Quick Ratio |
|---|---|
|
(Excludes Inventory and Prepaid Expenses) |
Tabular Difference Between Current Ratio and Quick Ratio
The main difference between current ratio and quick ratio is that the current ratio considers all current assets, while the quick ratio deducts inventory and prepaid expenses, assessing only the most liquid assets. Both ratios measure the company’s ability to pay short-term liabilities.
| Basis | Current Ratio | Quick Ratio |
|---|---|---|
| Definition | Ratio of total current assets to current liabilities | Ratio of most liquid current assets to current liabilities |
| Also Called | Working Capital Ratio | Acid Test Ratio |
| Purpose | Shows ability to pay all short-term obligations | Shows ability to pay immediate urgent obligations |
| Assets Included | Cash, receivables, inventory, prepaid expenses, etc. | Only cash, receivables, and marketable securities |
| Is Inventory Included? | Yes | No |
| Is Prepaid Expense Included? | Yes | No |
| Strictness | Less strict indicator of liquidity | More strict indicator of liquidity |
Example Calculation: Current Ratio and Quick Ratio
Let’s solve a simple example. Suppose a company has:
- Cash: ₹20,000
- Accounts Receivable: ₹10,000
- Inventory: ₹30,000
- Prepaid Expenses: ₹5,000
- Current Liabilities: ₹32,000
Current Ratio:
- = (20,000 + 10,000 + 30,000 + 5,000) / 32,000
- = 65,000 / 32,000 = 2.03
Quick Ratio:
- = (20,000 + 10,000) / 32,000
- = 30,000 / 32,000 = 0.94
Significance and Limitations
Both ratios are used by investors, lenders, and management to judge a business’s liquidity. The current ratio gives a broad view, but can be distorted if large inventories are held. The quick ratio gives a more realistic idea of immediate solvency, but may not suit businesses with slow-moving receivables.
How to Use This Knowledge for Exams and Business
In Class 12 Accountancy or competitive exams, be ready to define both ratios, write formulas, and solve numerical problems. Use Ratio Analysis pages on Vedantu to practice questions and for board exam revision. In real business, these ratios help managers and creditors assess short-term financial health.
Tips for Writing “Difference Between Current Ratio and Quick Ratio” in Exams
- Write definitions and formulas for both ratios.
- Mention what assets each includes and excludes.
- Use a tabular format for pointwise comparison.
- State the alternative names (Working Capital Ratio and Acid Test Ratio).
- Add one example/numerical if required.
- Revise from trusted sources like Accounting Ratios and Financial Statements for clarity.
At Vedantu, we simplify Commerce and Accountancy concepts so students build strong foundations for exams and business use. For deeper study, visit Current Assets or Solvency Ratio to understand related ratios and their practical importance.
In summary, understanding the difference between current ratio and quick ratio helps students and professionals assess a firm’s liquidity and financial safety. While the current ratio provides a broad liquidity view, the quick ratio offers a sharper test of immediate solvency. Both ratios remain key components of financial analysis and exam preparation.
FAQs on Difference Between Current Ratio and Quick Ratio
1. What is the primary difference between the current ratio and the quick ratio?
The primary difference lies in the assets used for calculation. The current ratio measures a company's ability to pay short-term liabilities using all its current assets. In contrast, the quick ratio provides a more conservative measure by excluding less liquid assets like inventory and prepaid expenses, focusing only on assets that can be quickly converted to cash.
2. What are the formulas to calculate the current ratio and the quick ratio?
The formulas for these two key liquidity ratios as per the Class 12 CBSE syllabus are:
- Current Ratio = Current Assets / Current Liabilities
- Quick Ratio (or Acid-Test Ratio) = (Current Assets - Inventory - Prepaid Expenses) / Current Liabilities. Alternatively, it can be calculated as Quick Assets / Current Liabilities.
3. What are quick assets, and how are they different from current assets?
Current assets are all assets a company expects to convert into cash within one year, including cash, accounts receivable, inventory, and prepaid expenses. Quick assets are a subset of current assets that can be converted into cash very quickly, typically within 90 days. To calculate quick assets, you start with total current assets and subtract inventory and prepaid expenses.
4. Why are inventory and prepaid expenses excluded when calculating the quick ratio?
Inventory and prepaid expenses are excluded for two distinct reasons based on the principle of liquidity:
- Inventory: It cannot be assumed that inventory will be sold immediately. There is also no guarantee it will be sold at its full book value, especially during a financial crunch.
- Prepaid Expenses: These represent future services a company has already paid for (like insurance or rent) and cannot be converted back into cash to pay off other liabilities.
By removing them, the quick ratio gives a more realistic picture of a firm's immediate debt-paying capacity.
5. Can you explain the difference between current ratio and quick ratio with a simple example?
Certainly. Imagine a company with the following details:
- Cash: ₹20,000
- Accounts Receivable: ₹40,000
- Inventory: ₹50,000
- Current Liabilities: ₹50,000
Total Current Assets = ₹20,000 + ₹40,000 + ₹50,000 = ₹1,10,000
Current Ratio Calculation:
₹1,10,000 / ₹50,000 = 2.2
Quick Ratio Calculation:
(₹1,10,000 - ₹50,000 Inventory) / ₹50,000 = ₹60,000 / ₹50,000 = 1.2
This example shows that while the company seems very liquid with a 2.2 current ratio, the quick ratio of 1.2 gives a more conservative view by showing its ability to cover debts without relying on selling its inventory.
6. What does a high quick ratio (e.g., above 1:1) signify for a company?
A quick ratio of 1:1 is often considered a benchmark, indicating that a company has exactly enough liquid assets to cover its current liabilities without needing to sell inventory. A ratio significantly above 1:1 suggests strong short-term financial health and a low risk of default on immediate obligations. However, an excessively high ratio might also suggest that the company is not using its assets efficiently to generate profits.
7. Are the 'quick ratio', 'liquid ratio', and 'acid-test ratio' different from each other?
No, these three terms refer to the exact same financial metric. For the purpose of Class 12 Accountancy and general financial analysis, 'Quick Ratio', 'Liquid Ratio', and 'Acid-Test Ratio' are used interchangeably to describe the ratio of quick (or liquid) assets to current liabilities.
8. What are the limitations of using only the current ratio to assess a company's liquidity?
Relying solely on the current ratio can be misleading. Its main limitation is the quality of current assets. A company might have a high current ratio due to a large amount of slow-moving or obsolete inventory. This inventory might not be easily convertible to cash, thus overstating the company's true ability to meet its short-term debts. This is the primary reason the quick ratio is also used for a more stringent analysis.
9. How is the quick ratio different from the even stricter cash ratio?
The cash ratio is the most conservative liquidity ratio and is even stricter than the quick ratio. While the quick ratio includes accounts receivable in its calculation, the cash ratio excludes them. The formula is (Cash and Cash Equivalents + Marketable Securities) / Current Liabilities. It only considers assets that are cash or can be converted to cash almost instantly, ignoring the risk that accounts receivable may not be collected in time.
10. How do the current and quick ratios help investors and lenders evaluate a business?
These ratios are vital for external stakeholders:
- Lenders and Creditors: They use these ratios to assess the creditworthiness and risk associated with extending short-term loans or credit. A strong ratio indicates a company can comfortably pay its bills, reducing the lender's risk.
- Investors: They look at these ratios to gauge a company's operational efficiency and financial stability. A declining liquidity ratio over time could be a warning sign of poor cash management or underlying business problems.
