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The Daily Technical #112: Could you define what the capital structure of a company represents?

How to answer "What is the difference between the current ratio and the quick ratio?"

February 13, 2025

Good afternoon. Welcome to the 112th edition of The Daily Technical.

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OVERVIEW OF YESTERDAY’S QUESTION
What is the difference between the current ratio and the quick ratio?

The current ratio and quick ratio are used to assess a company’s near-term liquidity position.

The two ratios are both used to determine if a company can meet its short-term obligations using just its short-term assets at the present moment.

Current Ratio: A current ratio greater than 1 implies that the company is financially healthy in terms of liquidity and can meet its short-term obligations.

Current Ratio = Current Assets / Current Liabilities

Quick Ratio: Otherwise known as the acid-test ratio, the quick ratio measures short-term liquidity but uses stricter policies on what classifies as a liquid asset.

Therefore, it includes only highly liquid assets that could be converted to cash in less than 90 days with a high degree of certainty.

Quick Ratio = (Cash & Cash Equivalents + AR + Short Term Investments) / Current Liabilities

Common Mistakes

  1. Misunderstanding what a certain ratio value indicates. For clarity, a current ratio over 1 suggests liquidity sufficiency, while the quick ratio provides a sterner test, requiring exclusions to better gauge immediate cash availability.

  2. Not acknowledging the inherent limitations each ratio has. It’s crucial to recognize that neither ratio gives a full picture of company health; they should be used alongside other financial metrics and qualitative assessments.

TL;DR

  • Current Ratio: Measures ability to meet short-term obligations with all current assets.

    Formula: Current Assets / Current Liabilities. Desirable ratio > 1 indicates good liquidity.

  • Quick Ratio: Stricter measure, uses highly liquid assets convertible to cash within 90 days.

    Formula: (Cash & Cash Equivalents + Accounts Receivable + Short-Term Investments) / Current Liabilities.

  • Key Difference: Quick ratio excludes inventory and other less-liquid assets, providing a conservative liquidity assessment.

DEAL TALK
Nationwide acquires Allstate's Group Health Business

Key Highlights

  • Transaction Overview: Allstate divests its Group Health unit for $1.25B in cash

  • Strategic Rationale: Allstate streamlines core operations; Nationwide amplifies its footprint in employer-sponsored health coverage

  • Financial Impact: $450M book gain for Allstate and $900M in deployable capital, while Nationwide strengthens its insurance portfolio

TODAY’S QUESTION
Could you define what the capital structure of a company represents?

Type your answer here. Within 60 seconds you’ll have custom feedback in your inbox.

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