Distinguish between the current ratio and the quick ratio.

Distinguish between the current ratio and the quick ratio.

• A. Current ratio = total assets / total liabilities; quick ratio = cash / current liabilities
• B. Current ratio = current assets / current liabilities; quick ratio = (current assets - inventories) / current liabilities
• C. Current ratio = sales / current liabilities; quick ratio = (cash + receivables) / current liabilities
• D. Current ratio = current assets / current liabilities; quick ratio = current assets / (current liabilities - inventories)

Answer: (B)

Liquidity measures compare readily available resources to short-term obligations. The current ratio assesses all current assets against current liabilities, showing how many dollars of short-term assets exist per dollar of short-term debt. The quick ratio tightens this by excluding inventories, since inventories are not as readily convertible to cash; it uses (current assets minus inventories) divided by current liabilities. Thus, the correct formulations are current assets divided by current liabilities for the current ratio, and (current assets minus inventories) divided by current liabilities for the quick ratio. The other approaches mix long-term or non-liquid items (like total assets or total liabilities), use inappropriate numerators (such as sales or cash only), or alter the denominator in an incorrect way, so they don’t reflect the standard definitions.

Liquidity measures compare readily available resources to short-term obligations. The current ratio assesses all current assets against current liabilities, showing how many dollars of short-term assets exist per dollar of short-term debt. The quick ratio tightens this by excluding inventories, since inventories are not as readily convertible to cash; it uses (current assets minus inventories) divided by current liabilities. Thus, the correct formulations are current assets divided by current liabilities for the current ratio, and (current assets minus inventories) divided by current liabilities for the quick ratio. The other approaches mix long-term or non-liquid items (like total assets or total liabilities), use inappropriate numerators (such as sales or cash only), or alter the denominator in an incorrect way, so they don’t reflect the standard definitions.