Working Capital, Liquidity, Current Ratios, Ratio Analysis; Working Capital
Liquidity refers to how quickly an asset can be converted into cash. Liquid Assets include cash as well as any other current asset that can easily be turned into cash. Customer liquidity is often measured using ratio analysis. The various liquidity ratios measure a company's ability to paying maturing short term debts as they become due.
Current Ratio: The current ratio gauges how capable a business is in paying current liabilities by using current assets only. Current ratio is also called the working capital ratio. A general rule of thumb for the current ratio is 2 to 1 (or 2:1 or 2/1). However, an industry average may be a better standard than this rule of thumb. The actual quality and management of assets must also be considered.
The formula is: Total Current Assets / Total Current Liabilities
Quick Ratio: Quick ratio focuses on immediate liquidity (i.e., cash, accounts receivable, etc.) but specifically ignores inventory. Also called the acid test ratio, it indicates the extent to which you could pay current liabilities without relying on the sale of inventory. Quick assets are highly liquid and are immediately convertible to cash. A general rule of thumb states that the ratio should be 1 to 1 (or 1:1 or 1/1).
The formula is: Cash + Marketable Securities+Accounts Receivable / Current Liabilities
Note that this ratio specifically excludes Short Term Investments. Short term investments are current assets but not quick assets.
Working Capital: Working capital is simply Current Assets minus Current Liabilities. This figure can be either positive or negative. Working capital measures a company's ability to pay current obligations as they come due.
Edited by Michael C. Dennis. Mr. Dennis is business credit consultant. He can be reached by email at email@example.com with questions or business inquiries.