Key Insight
Inventory is in the current ratio but out of the quick ratio — and that distinction matters. A retailer with $500K in inventory looks liquid until you realize the inventory hasn't moved in 18 months.
The Formula
Quick Ratio = (Cash + Accounts Receivable) ÷ Current Liabilities
Also expressed as: (Current Assets − Inventory − Prepaid Expenses) ÷ Current Liabilities
The logic: inventory and prepaids can't be immediately converted to cash — so they're stripped out to show only the most liquid assets.
Quick Ratio vs. Current Ratio
The gap between a company's current ratio and quick ratio reveals how much of its liquidity is tied up in inventory:
- Current ratio: 2.1x, Quick ratio: 1.8x → minimal inventory dependency, healthy
- Current ratio: 2.4x, Quick ratio: 0.9x → almost all "liquidity" is inventory — real cash position is weak
For service businesses with little inventory, the two ratios are nearly identical. For retail, wholesale, or manufacturing businesses, the gap is significant.
When It Matters in Acquisitions
Inventory-heavy businesses: If a seller is claiming strong working capital but it's primarily inventory, verify the inventory's age and liquidation value. Slow-moving or obsolete inventory is often overvalued on the balance sheet.
Seasonal businesses: At the seasonal peak, a retailer's inventory may inflate the current ratio; the quick ratio stays stable and gives a truer read on underlying liquidity.
Generally accepted benchmark: A quick ratio above 1.0 is considered adequate. Below 1.0 means the business depends on selling inventory just to meet current obligations.
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