Current Ratio
The Current Ratio, also known as the working capital ratio, is the ratio between Current Assets and Current Liabilities. It is a measure of the short-term liquidity of a business. Current Assets are those items on a company’s Balance Sheet which they can convert into cash within a year. Current Liabilities are the obligations and debts of a company that they have to pay off within a year.
The ideal ratio here should be equal to or greater than 2:1. It helps companies determine whether their Current Assets are sufficient to pay off the Current Liabilities.
Liquid Ratio
The Liquid Ratio, also known as the quick or acid test ratio, is the ratio between Liquid Assets and Current Liabilities. Liquid Assets are a part of Current Assets, and it includes only those items that a company can convert into cash within 90 days or less. It contains items like cash and cash equivalents, marketable securities and accounts receivable.
The ideal Liquid Ratio for a company should be 1:1 or more, and it indicates that the company can meet its immediate liability obligations through Liquid Assets.
Differences between Current Ratio and Liquid Ratio
Some of the major differences between Current Ratio and Liquid Ratio are as follows:
Current Ratio | Liquid Ratio |
Definition |
The Current Ratio is the ratio between the Current Assets and the Current Liabilities of a company. | The Liquid Ratio is the ratio between the Liquid Assets and the Current Liabilities of a company. |
Purpose |
The Current Ratio helps the firm assess its capability to meet any short-term obligations that may arise while conducting business. | The Liquid Ratio helps a firm assess its capability to meet any urgent requirements for cash that may arise while conducting business. |
Current Assets |
The Current Ratio includes all the Current Assets of the business. | The Liquid Ratio includes only those Current Assets that the firm can liquidate to cash within the next ninety days. |
Inventory |
The Current Ratio includes the inventory stock of a firm. | The Liquid Ratio excludes the inventory stock of a firm. |
Ideal Ratio |
Although anything more than 1 is the ideal scenario for a company, a Current Ratio of 2:1 is preferable. | The ideal Liquid Ratio for a company is more than 1. |
Approach for Paying Debt |
The Current Ratio is a much more relaxed method of finding out whether a company can repay its creditors in case of an emergency. | The Liquid Ratio is a much more stringent method of finding out whether a company can repay its creditors in case of an emergency. |
Comparison |
The Current Ratio will be naturally higher for a company that has a higher stock of inventory. | The Quick Ratio will be naturally lower for a company that has a higher stock of inventory. |
Conclusion
While it is impossible to analyse a company’s liquidity accurately, these accounting ratios can give us some idea in that direction. There are many differences between the Current Ratio and Liquid Ratio as stated above. But both of them are important to assess the ability of a business to clear off its debts in an emergency. It also helps a firm plan ahead in terms of keeping enough cash reserves for such situations.
Frequently Asked Questions
Q1
Give a list of the items included in the Current Assets while calculating the Current or Liquid Ratio.
The Current Assets include items like cash in hand, trade receivables, cash at the bank, sundry debtors, short-term loans and advances, inventories, prepaid expenses and disposable investments.
Q2
Give a list of the items that are included in the Current Liabilities while calculating the Current or Liquid Ratio.
The Current Liabilities include items like creditors, overdraft, outstanding expenses, short-term loans, proposed dividends, unclaimed dividends, provision for taxes and advances from customers.
Q3
Why is the Liquid Ratio considered to be more conservative compared to the Current Ratio?
The Liquid Ratio includes only the Liquid Current Assets (items that the firm can liquidate within ninety days), while the Current Ratio includes all the Current Assets. It is why Liquid Ratio is considered a more conservative estimate of a firm’s preparedness to meet emergency liability needs.
Also See:
- Difference between Under Subscription and Over Subscription of Shares
- Difference between Convertible and Non-Convertible Debentures
- Difference between Comparative Financial Statement and Common Size Financial Statement
- Difference between Fixed Assets and Current Assets
FAQs
The Current Ratio helps the firm assess its capability to meet any short-term obligations that may arise while conducting business. The Liquid Ratio helps a firm assess its capability to meet any urgent requirements for cash that may arise while conducting business.
What is the difference between current and liquid assets? ›
The main difference between Current Assets and Liquid Assets is that Current assets represent assets expected to be converted into cash or used up within a year, while Liquid assets are a subset of current assets and can be quickly converted into cash. Vary in liquidity. For example, inventory is less liquid than cash.
What is the main difference between the current ratio and the quick ratio? ›
Both ratios measure how well a business will meet its financial obligations using its existing assets. The main difference in looking at current ratio vs. quick ratio is that the quick ratio only uses the most liquid assets in its formula, while the current ratio uses all current assets.
What is the ideal current ratio and liquidity ratio? ›
A good current ratio is between 1.2 to 2, which means that the business has 2 times more current assets than liabilities to covers its debts. A current ratio below 1 means that the company doesn't have enough liquid assets to cover its short-term liabilities.
Which ratio explains the relationship between liquid assets and current? ›
The ratio of liquid assets to current liabilities is called liquid ratio. This ratio is used to measure the firm's ability to pay current liabilities immediately.
What is the difference between liquid ratio and current ratio? ›
The Current Ratio includes the inventory stock of a firm. The Liquid Ratio excludes the inventory stock of a firm. Although anything more than 1 is the ideal scenario for a company, a Current Ratio of 2:1 is preferable. The ideal Liquid Ratio for a company is more than 1.
Are liquidity ratio and current ratio the same? ›
The current ratio is a liquidity ratio that measures a company's ability to pay short-term obligations or those due within one year. It tells investors and analysts how a company can maximize the current assets on its balance sheet to satisfy its current debt and other payables.
What is the liquid ratio? ›
Liquidity ratios are a measure of the ability of a company to pay off its short-term liabilities. Liquidity ratios determine how quickly a company can convert the assets and use them for meeting the dues that arise. The higher the ratio, the easier is the ability to clear the debts and avoid defaulting on payments.
What is the liquid ratio also known as? ›
Quick ratio and acid test ratio are other names for liquid ratio.
What does a current ratio tell you? ›
The current ratio is a comparison of a company's current assets to current liabilities that can be used to find its liquidity, usually as a comparison between companies in the same industry. Potential creditors use the current ratio to measure a company's ability to pay off short-term debt.
A weakness of the current ratio is that it doesn't take into account the composition of the current assets. the difficulty of the calculation. that it is rarely used by sophisticated analysts. that it can be expressed as a percentage, as a rate, or as a proportion.
What is a bad current ratio? ›
If your current ratio is low, it means you will have a difficult time paying your immediate debts and liabilities. In general, a current ratio of 2 or higher is considered good, and anything lower than 2 is a cause for concern.
What current ratio is too high? ›
A high ratio (greater than 2.0) indicates excessive current assets in the form of inventory, and underemployed capital. A low ratio (less than 1.0) indicates difficulty to meet short-term financial obligations, and the inability to take advantage of opportunities requiring quick cash.
What is a good current ratio range? ›
As a general rule of thumb, a current ratio in the range of 1.5 to 3.0 is considered healthy. However, a current ratio <1.0 could be a sign of underlying liquidity problems, which increases the risk to the company (and lenders if applicable).
Does a higher current ratio mean more liquidity? ›
Comparing previous periods to current operations allows analysts to track changes in the business. In general, a higher liquidity ratio shows a company is more liquid and has better coverage of outstanding debts.
What are the two purposes of liquidity ratio? ›
A liquidity ratio is used to determine a company's ability to pay its short-term debt obligations. The three main liquidity ratios are the current ratio, quick ratio, and cash ratio. When analyzing a company, investors and creditors want to see a company with liquidity ratios above 1.0.
What are examples of liquid assets? ›
Anything of financial value to a business or individual is considered an asset. Liquid assets, however, are the assets that can be easily, securely, and quickly exchanged for legal tender. Your inventory, accounts receivable, and stocks are examples of liquid assets — things you can quickly convert to hard cash.
What is considered a liquid asset? ›
Liquid assets refer to cash on hand, cash on bank deposit, and assets that can be quickly and easily converted to cash. The common liquid assets are stock, bonds, certificates of deposit, or shares.
What is an example of a current asset? ›
Current assets include cash, cash equivalents, accounts receivable, stock inventory, marketable securities, pre-paid liabilities, and other liquid assets. The Current Assets account is important because it demonstrates a company's short-term liquidity and ability to pay its short-term obligations.
Are current assets the most liquid assets? ›
Examples of non-current assets include real estate, equipment, long-term investments, and long-term receivables. They're reported on the balance sheet below the current assets. Current assets are more liquid than non-current assets, and they're harder to convert into cash.
