Financial Accounting: An Integrated Statements Approach, 2nd Edition

Current Ratio. Financial ratios that measure the degree to which current assets are

available to satisfy current liabilities are called liquidityratios. One of the most pop-

ular liquidity ratios is the current ratio, which is calculated as follows:

Current Ratio

Current Assets

Current Liabilities

The current ratio measures the degree to which current assets are available to pay the

current liabilities. For example, a current ratio of 2.0 would indicate that current assets

are twice as large as current liabilities. A current ratio exceeding 2.0 would generally

indicate favorable liquidity, although this guideline may differ across industries.

Quick Ratio. A second liquidity ratio used by analysts is the quick ratio, or acid-

test ratio, which is calculated as follows:

Quick Ratio

Quick Assets

Current Liabilities

Quick assetsare cash, cash equivalents, temporary investments, and receivables that

can be quickly converted into cash. Notice that inventories and prepaid items are ex-

cluded from the numerator. Thus, the quick ratio measures the “instant” current debt-

paying ability of a company. A quick ratio exceeding 1.0 is often considered desirable,

which again may differ for some industries. A ratio less than 1.0 would indicate that

current liabilities cannot be covered by cash and “near cash” assets.

Illustration of Current and Quick Ratios. To illustrate the current and quick ra-

tios, refer to the partial balance sheet information for Barnes & Noble, Inc., and

Borders, Inc., in Exhibit 16. The current ratio for Barnes & Noble and Borders would

be calculated as follows:

Barnes & Noble, Inc.:$1,970.01.49

$1,325.6

Borders, Inc.:$1,765.41.48

$1,196.0

464 Chapter 10 Liabilities

Barnes & Noble, Inc. Borders, Inc.

Jan. 29, 2005 Jan. 23, 2005

(in millions) (in millions)

Current assets:

Cash and cash equivalents $ 535.7 $ 244.8

Temporary investments — 95.4

Receivables, net 74.6 118.3

Merchandise inventories 1,274.6 1,306.9

Prepaid expenses and other current assets 85.1 0.0

Total current assets $1,970.0 $1,765.4

Current liabilities:

Short-term debt and current portion of

long-term debt $ 0.0 $ 141.2

Accounts payable 745.1 615.1

Accrued liabilities 580.5 439.7

Total current liabilities $1,325.6 $1,196.0

Exhibit 16

Partial Balance Sheets

for Barnes & Noble,

Inc., and Borders, Inc.