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The difference between current ratio and quick ratio is that the former includes inventory in its equation, while the latter does not. Current ratio measures the liquidity of a company by dividing the current assets by the current liabilities. The quick ratio does essentially the same thing, but can be used when the inventory attached to the company is of a variable value.
Assessing the long-term value of inventory can help an analyst when deciding between current ratio and quick ratio as a means of determining company liquidity. There are several reasons an inventory may not keep its original sale value. A company may need to mark down prices in order to make sufficient sales to stay profitable or even to remain in business. It may also be necessary to drop prices when too much capital is tied up in inventory.
When determining liquidity, an analyst may use both the current ratio and quick ratio. The quick ratio may be used first, in order to determine that the company has the resources to make operating costs. Then the current ratio could be used to determine the actual current liquidity.
Whether to use the both the current and quick ratio or to choose one or the other depends on the company being researched. For a significant investment, both ratios can be valuable. An analyst who simply wants to know if the company has sufficient liquid assets to stay afloat may only need the quick ratio. If it has been determined that inventory value will likely stay stable, then the current ration will often suffice.
Over the long term, tracking both current ratio and quick ratio can help an analyst to determine if inventory is being kept at a beneficial level. The company could have too much inventory if the quick ratio drops while the current ratio stays stable. In this case, a company would want to improve its quick ratio. The primary ways to address this are to either increase sales or gradually decrease the amount of inventory.
Both the current and quick ratios can be used to determine not only the amount of cash available, but how it is being used. If the ratios are low, then it is possible that a large portion of the company’s cash is being used for operating expenses. It is also possible that that too many of its resources are tied up in other ventures and are not readily available for operations. If the ratio is too high, then the company may not be able to invest its surplus cash in ventures that will increase profits.
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