Current and Quick ratio

Hi everyone,

Today We will see how the two so-called liquidity ratios are related .

We will talk about current ratio and quick ratio. It is defined by the formulas :

1)Current ratio=Total Assets/Current liabilities

2)Quick ratio=(Current assets-inventories)/Current liabilities=(cash(the most liquid assets)+marketable securities( also relatively liquid)+accounts receivables)/Current liabilities

(Note that securities are less liquid than cash . Account receivable is money that customers owe to the company , e.g. they have already used the product that haven't paid for it yet)

I will first talk about current ratio and after that I will point out the only difference between the two financial rations.

So , The formulas are really self-explanatory . Just looking at it , it shows you that given you have assets and you have some debt , what the ratio is between the two. Remember that total assets include all forms short term assets material,cash,inventory,etc. that represent some value- it is valued by others . As you can imagine , current ratio could be used as a financial indicator of the current performance of a company. I highlighted current in the last sentence for a particular reason. Why I did that? Well , current ratio can be misleading ,because it shows only the net quantity of assets and liabilities .But as you can imagine we are interested more in the long run financial statements ,that are representative and that shows how the two have evolved over the time -this can give you some general idea how the company has been operating for the last year/quarter .

The only thing that is not included in quick ratio is inventories.These are the ready products that are in stock, that are not in circulation. This means that this ratio is really relevant for the net liquidity -> as we pointed out quick ratio represents what it would happen if the company has to pay all its debt to its borrowers and if it is below 1 then it means it will have liquidity problems and vice versa if it is above 1 , it will pay all its debt and still left with some assets , depending on what the ratio is  .

As we defined the two liquidity ratios , we may spot some things.We already introduced the balance sheets,income statement and cash flows and very soon you will be given detailed information about each indicator and what it represents . You will have to understand it because  they show what was the accountancy plan for e.g. the last quarter/year and you can make judgements why it is good or why it is bad ( you can find those financial statements in finance.yahoo.com ). One good example would be inventory . This can be counted as part of total assets-> it is short term , i.e. it is expected to be utilized at some point in the mere future. So , imagine that the company actually have a lot of inventory in circulation . The instant example that came to my head was Amazon, but let's try to find something else. I will give some intuition of how you can find a company that has a lot of inventories …

I was looking for a good example when the current ratio may not be a good representation . If you want a company that has current ratio below 1 and quick ration above 1 (i.e. this means that this company could potentially have liquidity problems if all its borrowers decide to take their money back). So , I went to finviz.com and I put the two indicators Current ratio>1,5 and Quick ratio<1 , which is like they have a lot of inventory . I came up with 124 companies and I just ordered them by market capitalization to see more famous tickers . I chose CSV (Caremark Corporation) looking at the two ratios : QR=0,9 and CR=1,6 . So  why I gave you this example ? Because if a company has a lot of inventory this could potentially mean that it has some plan . Even with our example CSV , these are drug stores in USA , maybe they want to expand oversees , otherwise why would they have so much inventory .( it could be because of good precious sales and bad current sales , but looking at the other indicators , this is highly unlikely . Of course , you need further investigation , but this is the first impression – I am not saying whether it is right or wrong ! )

So , next time we will talk about time period changes because current and quick ratio are just the financial condition in some point of time – not very representative!

I posted the main indicators  for CSV taken from finviz.com , I wanted to show you that , it is not enough if you want more insight into the operational system , that is why you need look for other sources.

Market Cap	87.44B
Income	4.60B
Sales	126.76B
Quick Ratio	0,9
Current Ratio	1,6
Debt/Eq	0.35
LT Debt/Eq	0.34

See you soon!

Links and sources :

• http://www.investopedia.com/terms/q/quickratio.asp
• http://www.investopedia.com/terms/c/currentratio.asp
• The example of a company with a lot of investories http://www.finviz.com/quote.ashx?t=CVS&ty=c&ta=1&p=d&b=1 

Chief Editor :Plamen Filipov
Contact: Plamen.S.Filipov@hotmail.com

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