Liquidity Ratios
Current Ratio – The Current Ratio in the Balance Sheet example shown earlier is the mathematical relationship of Current Assets to Current Liabilities: (Current Assets $117,040 / Current Liabilities $57,480 = $2.04) For every $1 of Current Liabilities there is $2.04 in Current Assets. This indicates a good liquid position and now you can see how management can quickly see how the company’s liquidity is. Liquidity is the time needed for assets to turn into cash versus amount needed to pay short term payables.
Quick Ratio – The Quick Ratios often referred as the Acid-Test Ratio because you use the most liquid of the Current Assets (Cash, Accounts Receivable, and Finished Goods Inventory). Therefore in this example Quick Ratio Assets = $96,760 / Current Liabilities $57,480 = $1.68). For every $1 of Current Liabilities there is $1.68 in Quick Ratio Assets, a very liquid position.