Lessons · Accounting · current ratio, quick ratio, debt-to-equity
Three ratios a lender reads first
Current ratio is current assets over current liabilities: can the business pay what is due this year. Quick ratio takes inventory out of the top, because stock is slow to turn into cash. Debt-to-equity is total liabilities over equity: how much of the business the lenders already own.
Hone is a place to practise a career, one idea a day. This is one of its lessons, written out in full and free to read without an account.
What it is for
A lender asks whether the business can pay them back next month, and whether it is already carrying too much debt. These three numbers, straight off the balance sheet, are the first thing they compute.
How to think about it
Take the four figures from the balance sheet: current assets, inventory, current liabilities, and total liabilities with equity. Three divisions. Read each as a number, not a percentage.
Worked example
Current assets 30,000 (of which inventory 12,000); current liabilities 15,000Off the balance sheet. Current means due or usable within a year.
Current ratio = 30,000 / 15,000 = 2.0Two dollars of near cash for every dollar due.
Quick ratio = (30,000 − 12,000) / 15,000 = 1.2Without the stock: still more than a dollar for every dollar due.
Total liabilities 40,000; equity 50,000 → Debt-to-equity = 40,000 / 50,000 = 0.8Lenders have 80 cents in the business for every dollar of the owner's.
Your turn
Current assets 50,000, current liabilities 20,000, quick ratio 1.5. Write the line with the inventory filled in.
Quick ratio = (50,000 − ) / 20,000 = 1.5
Solve one, graded on the server
The trap
Mixing long-term items into the current ratio. A building is an asset but it will not pay next month's suppliers; a ten-year loan is a liability but only this year's instalment is current.