Question

In: Accounting

What is the difference between current ratio and quick ratio. Explain with example ?

Expert Solution

LIQUIDITY RATIO

Liquidity Ratio Refers to a ratio which is used to find the liqudity position or short term position of a firm.

It is a ratio which indicates the short term debt paying capacity of a firm. It is useful to creditors and commercial banks that provides credit.

Current ratio qucik ratio are the liquidity ratio.

CURRENT RATIO

Current ratio is the common ratio for analysing liquidity or short term financial position of a firm current ratio is the ratio of current asset to current liabilities. It is also called Bankers ratio or working capital ratio.

Current Ratio = Current Ratio / Current Liability

It denotes the firms ability to pay its current liabilities out of current assets

* it denotes the firms ability to pay its current liabilities out of current asset

*Ideal current ratio is 2:1

which denotes that current asset are twice the current liabilities

*Higher the current ratio the greater the firms ability to meet short term debts

Limitation

The main limitation is that current ratio measures the availibity of current asset not the quality. Which means it does not include the liquidity of individual components of current assest.

*Another limitation is window dressing or manipulation the current asset and liability are manipulated to show better picture of liquidity

LIQUID RATIO OR QUICK RATIO

*Liquid ratio is the ratio of liquid asset or quick asset to current liabilities

*it is the measure of the immediate debt paying ability of business enterprise.It is also called acid test ratio

*The ratiois calculated to eliminate all possible liquid elements from the current assets

*it is also called Near money ratio.

Quick Ratio : Liquid Asset / Current Liabilities

* Ideal quick ratio is 1:1

*Quick ratio is considered to be more superior to current ratio in testing liquidity position of firm

*The combination of current ratio and quick ratio will help to test good liability

*if current ratio is ideal that is 2:1 and quick ratio 1:1 the liquidity position may be satisfactory .If current ratio is more than 2:1 and qucik ratio is less than 1:1 it indicates excessive inventory

DIFFERNCE BETWEEN CURRENT RATIO AND QUICK RATIO

CURRENT RATIO QUICK RATIO

*Current ratio indicates ability of firm to pay * Qucik ratio indicates the ability of firm to pay

current liability liability with in a month

*Current ratio indicates the relationship *Quick Ratio indicates the relationship betwwen

Between Current liabilities and current asset Qucik asset and current liability

*Ideal current ratio is 2:1 * Ideal quick ratio is 1:1

*Current ratio doesnot indicate true financial *Quick ratio removes the short coming of

position current ratio

*it includes large amount of stock * it excludes the amount of stock

Example

Find the current ratio and quick ratio

Machinery 310000

prepaid expense 3000

Sundry debtors 177500

Cash in hand 16500

short term investment 30000

Sundry creditors 160000

Stock 155000

Bills Payable 48000

Expense payable 13000

Long term loans 85000

Current Ratio = Current Asset

Current liability

Current assets - Prepaid expenses 3000

Sundry debtors 177500

cash 16500

Short term Investment 30000

Stock 155000

Total 382000

Current liabilities -Sundry creditors 160000

Bills Payble 48000

Expenses payable 13000

Total 221000

Current ratio = Current asset

Current liability

= 382000 = 1.73: 1

221000

Quick Ratio = Current asset - Stock

Current liabilities \

= 382000 - 145000 = 237000 = 1.07:1

221000 221000

ekkarill92 answered 2 years ago

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