Question

It is important to review not just the Current Ratio, but also the Quick Ratio and Cash Ratio because:

• the Cash Ratio must always provide a greater statistic than the Current Ratio and Quick Ratio.

• the Quick Ratio includes inventory that can be easily liquidated for cash.

• a low Current Ratio may not necessarily indicate a problem with a company.

• companies can operate with a Cash Ratio close to zero and maintain liquidity.

• GAAP requires it.

Answer 1

Current ratio denotes current liabilities to current assets. Here current assets include inventory, debtors, advances, bank balances, cash equivalents, cash etc. Current ratio measures if the firm can meet the short term liabilities.

In case of quick ratio, quick asset do not consider inventories. By quick ratio we can see if urgent requirements can be addressed by assets. Inventory can not be liquidated easily and hence it does not form quick asset.

Cash assets are those which are readily available with the firm and includes cash, bank and marketable securities.

In the light of above we can conclude that:

Cash ratio always can not provide better statistics than Current ratio and quick ratio, as without taking into account receivable and inventory we avoid a big part.

Quick ratio does not include inventory.

A low current ratio may create issues in meeting payables in timely manner.

Companies can not operate an zero cash ratio as it will create huge operational issues and GAAP does not require this.