How do current and quick ratios differ in liquidity assessment?

The current ratio measures a company's ability to pay short-term liabilities, while the quick ratio excludes inventory from current assets.

The current ratio, also known as the working capital ratio, is a liquidity ratio that measures a company's ability to pay off its short-term liabilities with its short-term assets. It is calculated by dividing a company's current assets by its current liabilities. Current assets include cash, accounts receivable, inventory, and other assets that can be converted into cash within one year. Current liabilities include accounts payable, accrued liabilities, and other short-term debt due within one year. A higher current ratio indicates a more promising financial health as it means the company has more assets to pay off its debts.

On the other hand, the quick ratio, also known as the acid-test ratio, is a more stringent measure of liquidity. It excludes inventory from current assets before dividing by current liabilities. This is because inventory may not be easily converted into cash, especially in the case of a sudden need for liquidity. The quick ratio only includes cash, marketable securities, and accounts receivable in its calculation. A higher quick ratio indicates a better position to meet its short-term liabilities without selling inventory, which is beneficial in industries where inventory may be difficult to liquidate quickly.

In summary, while both the current and quick ratios are used to assess a company's liquidity, they differ in their calculation and interpretation. The current ratio considers all current assets, while the quick ratio only considers the most liquid assets. Therefore, the quick ratio is a more conservative measure, providing a more realistic view of a company's liquidity position.