SingaporeAccountingSyllabus dot point

How do the current ratio and the quick ratio measure whether a business can pay its short-term debts?

Calculate and interpret the liquidity ratios: the current ratio and the quick (acid-test) ratio

A focused answer to the O-Level Principles of Accounts outcome on liquidity ratios. The current ratio and the quick (acid-test) ratio, what they reveal about paying short-term debts, and how to interpret them.

Generated by Claude Opus 4.88 min answerUpdated 2026-06-06

Reviewed by: AI editorial process; not yet individually human-reviewed

Have a quick question? Jump to the Q&A page

Jump to a section

What this dot point is asking
The answer
Examples in context
Try this

What this dot point is asking

SEAB wants you to calculate and interpret the two liquidity ratios: the current ratio and the quick (acid-test) ratio. The central insight is that liquidity is about whether a business can pay its short-term debts as they fall due, and the two ratios test this from least to most demanding, the quick ratio being the stricter because it excludes inventory.

The answer

The current ratio

The current ratio compares all current assets with current liabilities:

\text{Current ratio} = \frac{\text{Current assets}}{\text{Current liabilities}}

It is expressed as a ratio to 1 (for example $2 : 1$ ). A figure above $1 : 1$ means current assets exceed current liabilities, so the business can, in principle, cover its short-term debts. A commonly cited comfortable level is around $2 : 1$ , but this varies by industry.

The quick (acid-test) ratio

The quick ratio is stricter: it excludes inventory, the least liquid current asset, because inventory must first be sold and then the cash collected before it can pay a debt:

\text{Quick ratio} = \frac{\text{Current assets} - \text{Inventory}}{\text{Current liabilities}}

A quick ratio of about $1 : 1$ suggests the business can meet its current liabilities without relying on selling inventory. Below $1 : 1$ may signal liquidity strain.

Reading the two together

Pattern	What it suggests
Both healthy	Sound short-term liquidity
Current ratio fine, quick ratio low	Too much tied up in inventory
Both low	Possible difficulty paying short-term debts
Both very high	Possibly too much idle cash or stock (not earning)

Worked example

A business reports: inventory $\$ 30,000 $; trade receivables$ \ $18,000$ ; bank $\$ 2,000 $; trade payables$ \ $20,000$ ; accrued expenses $\$ 5,000$. Calculate both liquidity ratios and comment.

Step 1: Total current assets and current liabilities

Current assets $= 30\,000 + 18\,000 + 2\,000 = \$ 50,000 $. Current liabilities$ = 20,000 + 5,000 = \ $25,000$ .

Step 2: Current ratio

Current ratio $= \dfrac{50\,000}{25\,000} = 2 : 1$ . On the face of it, current assets are twice the current liabilities, which looks comfortable.

Step 3: Quick ratio

Quick ratio $= \dfrac{50\,000 - 30\,000}{25\,000} = \dfrac{20\,000}{25\,000} = 0.8 : 1$ . Excluding inventory, the most liquid assets only cover $80\%$ of current liabilities.

Step 4: Comment

The current ratio looks strong, but the quick ratio of $0.8 : 1$ shows the business depends heavily on inventory ( $\$ 30,000 $of its$ \ $50,000$ current assets). If that stock is slow to sell, it could struggle to pay debts on time, a warning the current ratio alone would hide.

Examples in context

Example 1. Stock-heavy and exposed. A furniture shop shows a current ratio of $2.5 : 1$ but a quick ratio of $0.6 : 1$ , because most current assets are large, slow-selling items. A sudden bill could not be met from cash and receivables alone; the shop would have to sell furniture fast, perhaps at a discount. The quick ratio flags this risk that the current ratio masks.

Example 2. Lean but liquid. A service business holds almost no inventory, so its current and quick ratios are nearly equal at about $1.3 : 1$ . It can comfortably meet short-term debts from cash and receivables. With little stock to worry about, the current ratio alone tells most of the liquidity story here.

Try this

Q1. Current assets are $\$ 60,000 $and current liabilities$ \ $30,000$ . State the current ratio. [1 mark]

Cue. Current ratio $= \dfrac{60\,000}{30\,000} = 2 : 1$ .

Q2. Current assets $\$ 45,000 $include inventory$ \ $20,000$ ; current liabilities are $\$ 25,000$. State the quick ratio. [2 marks]

Cue. Quick ratio $= \dfrac{45\,000 - 20\,000}{25\,000} = \dfrac{25\,000}{25\,000} = 1 : 1$ .

Q3. Explain why a business with a current ratio of $3 : 1$ might still face a liquidity problem. [2 marks]

Cue. If most of its current assets are slow-moving inventory, it may not turn them into cash quickly enough to pay debts; the quick ratio would reveal this.

Exam-style practice questions

Practice questions written in the style of SEAB exam questions on this dot point, with worked answer explainers. The year tag is the paper they imitate, not the source.

Original6 marksA business has: inventory

\

20\,000

; trade receivables

15\,000

; bank

\

5\,000

; trade payables

25\,000

; a bank overdraft

\

10\,000$. Calculate (a) the current ratio and (b) the quick (acid-test) ratio, each to two decimal places, and comment on the second.

Show worked answer →

Current assets $= 20\,000 + 15\,000 + 5\,000 = \$ 40,000 $. Current liabilities$ = 25,000 + 10,000 = \ $35\,000$ .

(a) Current ratio $= \dfrac{\text{current assets}}{\text{current liabilities}} = \dfrac{40\,000}{35\,000} = 1.14 : 1$ .

(b) Quick ratio $= \dfrac{\text{current assets} - \text{inventory}}{\text{current liabilities}} = \dfrac{40\,000 - 20\,000}{35\,000} = \dfrac{20\,000}{35\,000} = 0.57 : 1$ .

Comment: the quick ratio of $0.57 : 1$ is below $1 : 1$ , so without selling inventory the business cannot cover its current liabilities from its most liquid assets. This suggests possible short-term liquidity strain.

Markers reward the current ratio of $1.14 : 1$ , the quick ratio of $0.57 : 1$ (excluding inventory), and a comment that below $1 : 1$ signals possible difficulty paying short-term debts.

Original5 marksExplain the difference between the current ratio and the quick ratio, and why a business with a healthy current ratio might still have a liquidity problem.

Show worked answer →

The current ratio compares all current assets with current liabilities. The quick (acid-test) ratio excludes inventory from current assets, because inventory is the least liquid current asset (it must first be sold, and the cash collected, before it can pay debts).

A business can have a healthy current ratio (say $2 : 1$ ) yet still struggle if most of its current assets are inventory. If that inventory is slow-moving or hard to sell, the business may not be able to turn it into cash quickly enough to pay debts as they fall due. The quick ratio reveals this by stripping inventory out.

Markers reward the inventory exclusion as the key difference, and explaining that heavy reliance on inventory can hide a liquidity problem that the quick ratio exposes.