RALEIGH, N.C. – The current and quick ratio is an important benchmark for small business and franchise owners. Calculating it and comparing it to others in the same industry provides important insights into a business' solvency.
The current ratio assesses the ability of a company to meet its short-term obligations with the assets it has in hand that can quickly be turned into cash versus its current liabilities or obligations due in the next year. Current assets include cash, accounts receivable (what is owed the company for products or services purchased) and inventory. Current liabilities include debts that must be repaid within a year and accounts payable (or what the company owes to others). In general, a current ratio should exceed one, which means current assets match current liabilities.
And then there is the conservative quick ratio that shows more liquidity on whether a firm can pay its bills.
Quick ratio = Cash and equivalents + marketable securities + accounts receivables
current liabilities
Financial analyst Jenna Weaver cautions that one must know the industry. All current or quick ratios are not the same. For example, a company that keeps a lot of inventory on hand may have the same current ratio as one that has a lot in accounts receivables on hand. But when the going gets tough, the company with accounts receivables wins because it is easier to receive cash from receivables than sell inventory at clearance sale prices.
"Current ratio is one measure of a company's ability to stay solvent in the short term, but it's not everything," Weaver said. "It doesn't give the whole picture of a company's cash flow."
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