Working Capital, Current and Quick Ratios
Working capital is current assets minus current liabilities. The current ratio divides the two; the quick ratio leaves out inventory, which can be hard to sell fast. Both measure whether a company can pay its bills over the next year.
Working capital and the current and quick ratios show whether a company can cover the bills due over the next year. They come straight from the balance sheet. Accounting standards and how items are classified differ by country, so compare like with like.
- Category
- Fundamentals and Macroeconomics
- Reading time
- 3 min
- Also called
- Liquidity ratios, Current ratio, Quick ratio
- Updated
Liquidity ratios in plain words
Current assets are those a company expects to turn into cash within a year; current liabilities are bills due within a year.1
Working capital is what would be left if the company paid all its short-term debts out of its current assets.1
Loan agreements define the ratios precisely: the current ratio is current assets ÷ current liabilities, and the quick ratio removes inventory from current assets first.2
How to calculate liquidity ratios
Find current assets
List current assets — what should turn into cash within a year.1
Find current liabilities
List current liabilities — what must be paid within a year.1
Compute working capital
Subtract liabilities from assets: what is left if a company paid its current liabilities from its current assets.1
Compute the current ratio
Divide current assets by current liabilities.2
Compute the quick ratio
Remove inventory: Current Assets less inventory, to Current Liabilities.2
Compare within the industry
Compare with peers, since healthy levels differ by industry.1
Worked examples
Example 1 — Healthy cover
ComfortableA hypothetical firm has current assets of 300 and current liabilities of 150 (millions).
| Working capital | 150 |
| Current ratio | 2.0 |
A current ratio of 2 means two units of short-term assets for every unit of short-term debt.2
Example 2 — Inventory-heavy
Tighter than it looksThe same hypothetical firm holds 180 of its current assets in inventory.
| Quick assets | 120 |
| Quick ratio | 0.8 |
The quick ratio takes Current Assets less inventory, and drops below 1 here, so the firm relies on selling stock to pay bills.2
Example 3 — Negative working capital
Context neededA hypothetical retailer has current assets of 90 and current liabilities of 120.
| Working capital | −30 |
| Current ratio | 0.75 |
The ratio looks weak, but desirable ratios vary by industry; fast-selling retailers often run like this.1
Current ratio vs quick ratio
| Aspect | Current ratio | Quick ratio |
|---|---|---|
| Includes inventory | Yes | No |
| Strictness | Looser | Stricter |
| Best for | General liquidity | Firms with slow-moving stock |
| Rule-of-thumb | Above 1 | Near 1 |
Where liquidity ratios are used
Credit analysis
Lenders set ratio covenants; weak ratios raise Default Risk.
Stock screening
Part of Fundamental Analysis.
Dividend safety
Thin liquidity can threaten a Dividend.
Distress spotting
Falling ratios can flag future Distressed Debt.
Advantages and disadvantages
Advantages
- Simple to compute from the balance sheet.
- Quick read on short-term solvency.
- Quick ratio removes hard-to-sell inventory.
- Widely used in loan covenants.
Disadvantages
- Snapshot at one date only.
- Varies widely by industry.
- Ignores timing of cash inside the year.
- Classification rules differ by country.
Going deeper
Read as far as you need. Each level builds on the one before it.
Inside one year
Beginner
Why remove inventory
Intermediate
Inventory can take months to sell, so the quick ratio leaves it out of current assets.2
Classification rules
Advanced
Whether a debt counts as current depends on the accounting rules; IFRS amendments improved disclosure when a company's right to delay payment beyond twelve months depends on meeting covenants.3 US and local rules differ, so check the notes.
Common mistakes
Thinking higher is always better
Too much idle cash can hurt returns.
Comparing across industries
Norms vary widely.
Ignoring inventory quality
Old stock may sell at a loss.
Ignoring accounting differences
Rules differ by country.
Check your understanding
Test yourself before moving on. Each answer comes with an explanation.
Key points to remember
- Working capital = current assets − current liabilities.
- Current ratio divides the two.
- Quick ratio leaves out inventory.
- Norms vary by industry.
- Accounting rules differ by country.
Frequently asked questions
What is a good current ratio?
Is the quick ratio the acid-test ratio?
Are these ratios the same under all accounting rules?
Further learning
- Fundamental Analysis
Where ratios fit in.
- Liquidity
Liquidity in markets vs companies.
- Default Risk
What weak liquidity can lead to.
- Leverage
Long-term debt load.
Sources
This article is written in our own words. The sources below support the specific facts, rules and figures marked with a number in the text. Links open the original publisher’s page.
- SEC. Beginners' Guide to Financial Statements (opens in a new tab) Checked .
- SEC EDGAR (company filing exhibit). Loan agreement exhibit 10.5, defined terms (opens in a new tab) Checked .
- IFRS Foundation. IAS 1 Presentation of Financial Statements (opens in a new tab) Checked .
Educational content, not financial advice. Examples use hypothetical prices and simplified costs; actual fees, margin rules and regulations vary by broker, market and country. We are not affiliated with any publisher linked above. Last reviewed . Report an error or request a source credit.