Current Ratio & Quick Ratio: Will the Company Survive?

Concepts

Current Ratio: Can It Pay Its Short-Term Bills?

The formula:

Current Ratio = Current Assets / Current Liabilities

Current assets are things that can be converted to cash within one year (cash, accounts receivable, inventory). Current liabilities are obligations due within one year (short-term loans, accounts payable).

A current ratio above 1 means short-term assets exceed short-term liabilities, so the company can theoretically pay its bills. A ratio of 1.5 or higher is generally considered safe — it provides enough cushion even if some assets cannot be liquidated quickly.

However, an excessively high current ratio (e.g., above 5) is not necessarily good either. It may indicate the company is holding too much idle cash or has excessive inventory buildup.

Quick Ratio: Can It Actually Produce Cash Right Away?

The quick ratio is a stricter version of the current ratio:

Quick Ratio = (Current Assets − Inventory − Prepaid Expenses) / Current Liabilities

Why exclude inventory? Because inventory cannot always be sold quickly. If a batch of goods sits unsold in a warehouse, it is not cash. The quick ratio only counts assets that can be converted to cash quickly (cash, short-term investments, accounts receivable), making it a better reflection of a company's immediate ability to repay debt.

A quick ratio above 1 is generally recommended, meaning the company can cover its short-term obligations even without selling any inventory.

Interest Coverage Ratio: Are Earnings Enough to Cover Interest Payments?

The formula:

Interest Coverage Ratio = EBIT (Earnings Before Interest and Taxes) / Interest Expense

This metric shows how many times the company's operating profit covers its interest payments. If the interest coverage ratio is 5, the company earns five times its interest expense — paying interest is no problem.

A ratio above 3 is generally considered safe. Below 1.5 means almost all earnings go toward interest payments, indicating severe financial pressure. Below 1 means the company cannot even cover its interest — a very dangerous sign.

Using All Three Together

The safest combination is: current ratio > 1.5, quick ratio > 1, and interest coverage ratio > 3. However, standards vary by industry:

• Technology: Typically cash-rich with low debt — all three metrics tend to be strong
• Construction / Real Estate: Inventory (completed buildings) is a large asset, so the current ratio may be high while the quick ratio is low
• Financials: The business model is inherently built on borrowing and lending, so standard benchmarks do not apply

The critical thing is to watch the trend: if all three metrics are declining simultaneously, the company's financial health is deteriorating — that is a red flag.

Hands-On: Using CTSstock

1. Go to /analysis/2330 (using TSMC as an example)
2. Click the "Financial Ratios" tab at the top
3. Find the "Solvency" section
4. You will see historical data for the current ratio, quick ratio, and interest coverage ratio
5. Key things to watch:
   • Is the current ratio consistently above 1.5?
   • Is the quick ratio above 1? If the current ratio is high but the quick ratio is low, inventory makes up too large a share
   • Is the interest coverage ratio trending up or down?

FAQ

Q: Does a low current ratio mean the company is about to go bankrupt? A: Not necessarily. Some industries (e.g., convenience store chains and retail) inherently have low current ratios due to their business model, yet generate very stable cash flows. Always cross-check with operating cash flow.

Q: When is the interest coverage ratio not applicable? A: For companies with zero or very little debt, interest expense approaches zero, and the calculated ratio becomes extremely large (or even infinite). In such cases, the metric is not particularly useful because the company simply does not need to worry about interest payments.

Q: Which metric should I pay the most attention to? A: If the company has low debt, the current ratio and quick ratio matter more. If the company has significant borrowings, the interest coverage ratio becomes critical. Looking at all three together gives you the most complete picture.