The current ratio and the quick ratio both measure liquidity: can the business pay its short-term obligations as they fall due? Lenders calculate both, because together they show not just how many short-term assets you have, but how quickly those assets can turn into cash.
The formulas
Current ratio = Current assets ÷ Current liabilities
Quick ratio = (Current assets − Inventory − Prepaid expenses) ÷ Current liabilities
The quick ratio, sometimes called the acid-test ratio, removes inventory and prepayments because they can’t easily be used to pay a supplier or a bank next month.
Worked example
| Current assets | Amount |
|---|---|
| Cash and bank | 1,500,000 |
| Trade receivables | 4,500,000 |
| Inventory | 5,500,000 |
| Prepaid expenses | 500,000 |
| Total current assets | 12,000,000 |
| Total current liabilities | 8,000,000 |
- Current ratio = 12,000,000 ÷ 8,000,000 = 1.50
- Quick ratio = (12,000,000 − 5,500,000 − 500,000) ÷ 8,000,000 = 6,000,000 ÷ 8,000,000 = 0.75
The current ratio looks comfortable, but the quick ratio shows the business depends on selling its stock to meet its obligations.
How lenders read them
- Current ratio above 1.0 means current assets exceed current liabilities. Many lenders like to see 1.2–1.5 or more, depending on the industry.
- Quick ratio around 1.0 means the business could meet short-term liabilities without selling inventory. Lower figures are common in retail and distribution, where stock is the main asset.
- A big gap between the two signals heavy reliance on inventory, so lenders then look at inventory turnover and stock quality.
- A ratio that is too high can also be a concern: it may mean idle cash or slow-paying customers.
Why the trend matters more than one year
A current ratio falling from 1.6 to 1.1 over three years tells a lender more than a single figure. It may point to growing short-term borrowing, slower collections or losses eating into working capital.
Watch out for these distortions
- Overdue receivables still count as current assets but may never be collected. Check the receivables ageing.
- Short-term loans used to fund long-term assets push current liabilities up and the ratio down.
- Year-end window dressing, such as paying suppliers just before the balance sheet date, can flatter the figures for one day.
How to improve liquidity
- Collect receivables faster with clear credit terms and follow-up.
- Clear slow-moving stock.
- Refinance short-term debt used for long-term assets into a term loan.
- Retain more profit in the business.
Liquidity is one part of the picture. See the financial ratios banks use, the working capital cycle, and check your position with the working capital calculator.
What is a good current ratio by industry?
There is no single “right” current ratio. A supermarket that collects cash daily can run safely on a lower ratio than a contractor that waits months to be paid. These broad ranges are a useful starting point:
| Type of business | Typical current ratio | Typical quick ratio |
|---|---|---|
| Retail and supermarkets | 0.8 – 1.3 | 0.2 – 0.5 |
| Trading and distribution | 1.2 – 1.6 | 0.6 – 1.0 |
| Manufacturing | 1.2 – 2.0 | 0.6 – 1.0 |
| Construction and contracting | 1.1 – 1.5 | 0.8 – 1.2 |
| Services and consulting | 1.3 – 2.0 | 1.0 – 1.8 |
Treat these as rough guides, not rules. Lenders compare your ratios with similar businesses and, more importantly, with your own past years.
Which ratio do lenders rely on more?
For most working-capital facilities, credit analysts look at both, but they lean on different ones depending on the business:
- Stock-heavy businesses (traders, manufacturers): the quick ratio matters more. Lenders want to know whether the business can survive if stock is slow to sell.
- Service businesses, which hold little stock: the two ratios are almost the same, so the analyst may focus on the current ratio and on debtor days.
- Businesses asking for stock finance: the bank will also calculate a drawing power: eligible stock and receivables, minus a margin. That shows how much of the limit can actually be used.
Liquidity covenants
Many working-capital facilities carry a liquidity covenant, for example “current ratio not less than 1.1x”, tested on annual or half-yearly accounts. If the ratio drops below the covenant, the bank may ask for an explanation, a plan, or additional security. Read more in our guide to loan covenants.
From the credit desk
What we look for when this comes up in a real credit file:
- We look at the trend over three years, not one year. A current ratio slipping from 1.5 to 1.1 tells us more than a single 1.3.
- Analysts adjust the ratio by removing doubtful debtors, obsolete stock and related-party balances. Your adjusted ratio is often lower than the one in your accounts.
- A low quick ratio with a healthy current ratio means liquidity depends on selling stock. That is acceptable for some trading businesses, but expect questions about how fast stock converts to cash.
Worked example: Current assets of PKR 60 million, including PKR 25 million of stock, and current liabilities of PKR 45 million give a current ratio of 1.33 and a quick ratio of 0.78.
Frequently asked questions
Is a current ratio of 1 bad?
Not always. It means current assets exactly cover current liabilities. For a fast-moving retailer that is normal. For a manufacturer holding a lot of slow stock, it would worry a lender.
Can a current ratio be too high?
Yes. A very high ratio, say above 3.0, can mean cash is sitting idle, customers are paying slowly, or stock is building up. Lenders will ask why.
Does a bank overdraft count as a current liability?
Yes. Running finance, overdrafts and short-term loans are current liabilities, as is the current portion of long-term loans. Leaving them out is one of the most common reasons owners’ figures differ from the bank’s.
How is liquidity different from repayment capacity?
Liquidity ratios show whether you can meet short-term obligations from short-term assets. Repayment capacity, measured by DSCR, shows whether your cash flow can service debt over time. Lenders want both.
Sources and further reading
- State Bank of Pakistan: Laws and Regulations (Prudential Regulations)
- IFRS Foundation: IAS 2 Inventories
Related guides
- 6 Financial Ratios Banks Use to Judge Your Business (With Examples)
- DSCR Explained: Formula, What Counts as a Good Ratio, Stress Tests and How Banks Use It
- Inventory Turnover and Days Inventory: Formula and Worked Example
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