Calculated by dividing the company’s current assets by its current liabilities.
Current Ratio = Current Assets
Current Liabilities
This is a measure of a company’s working capital and reflects a company’s ability
to pay its short-term debts. A current ratio of 2.0 means that current assets are
double current liabilities. It is generally accepted that the current ratio should be
2.0 or more but this can vary according to the nature of the company. The nature
of the assets indicates the extent to which they can be converted to cash. A
reducing current ratio may indicate efficient management or that a company may
be facing difficulties. A company with a strong cash flow, turning stock over
quickly and collecting its debts quickly can handle a low current ratio.
Quick Ratio (Acid Test Ratio)
Calculated by dividing the company’s current assets less inventory by its current
liabilities.
Current Ratio = Current Assets – Inventory
Current Liabilities
This is often more meaningful than the current ratio as some current assets may
not be readily convertible to cash eg inventory. It is calculated by dividing current
liabilities into current assets less inventory. It is generally accepted that the quick
ratio should not be less than 1.0. While possible to operate with a lower level a
value significantly less than 1.0 is cause for concern, while 1.5 is excellent.