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Chapter 7

Working capital ratios

4.1 Liquidity ratios

Current ratio

This measures how much of the total current assets are financed by current liabilities.

A measure of 2:1 means that current liabilities can be paid twice over out of existing
current assets.

Current assets
Current ratio = –––––––––––––
Current liabilities

Quick (acid test) ratio

 Measures how well current liabilities are covered by liquid assets.

 Is particularly useful where inventory holding periods are long.

Current assets – Inventory
Quick ratio (acid test) = ––––––––––––––––––––
Current liabilities

A measure of 1:1 means that the entity is able to meet existing liabilities if they all fall
due at once.

Question 1

Current & quick ratios

A company has $25m of current assets, of which $5m are inventory. Its current
liabilities stand at $15m. Calculate the current and quick ratios.

Current ratio = $25m/$15m = 1.67

Quick ratio = ($25m – $5m) – $15m = 1.33

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