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IAI Actuarial Core Principles · Business Finance · Interpreting company accounting information

Which of the following is the most appropriate use of the current ratio and the quick (acid test) ratio when assessing short-term solvency?

The quick ratio removes inventory from current assets before dividing by current liabilities, because inventory may be slow to convert into cash. It therefore gives a stricter measure of short-term solvency than the current ratio, which can be flattered by slow-moving stock.

  1. AThe quick ratio excludes inventory because inventory may not be quickly convertible to cash, so it gives a stricter test of liquidity than the current ratioCorrect
  2. BThe quick ratio includes inventory but excludes receivables to focus on cash conversion
  3. CThe current ratio is always better when higher, regardless of the composition of current assets
  4. DThe quick ratio is calculated by dividing total debt by total assets
  5. The current ratio compares operating profit with interest payable

Explanation

The quick ratio takes current assets less inventory over current liabilities, giving a stricter liquidity test. A high current ratio may reflect slow-moving inventory, so it is not always better. The other options describe different ratios (debt ratio, interest cover).

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