If company’s current ratio is less than the industry, and its quick ratio is also less than the industry, which of these measures should most concern an analyst regarding the company’s working capital management?
Since Working Capital = CA-CL, I would think an analyst would be more concerned about the current ratio. The quick ratio takes out inventory and less liquid current assets and is more conservative. I guess it depends on the ultimate goal of the analysis.
I would say about the quick ratio, since the numerator in the quick ratio is CA-Inventory and is more a measure about short term liquidity.
I hate to say it, but I don’t have the answer. My first guess was that working capital is more concerned with Current Assets, so I would guess Current Ratio. Then, after some research, I learned that the Quick Ratio is more conservative (uses more liquid assets). I still don’t know what the answer is…it’s a coin toss.
Current ratio includes inventory in the numerator. If it is lower than the industry, you don’t know if it is because of lower inventory (a good sign if it s accompanied for instance by lower days receivables outstanding, as the company rolls over inventory more quickly than the industry) or because of a shortfall in short term liquidities (a really bad sign of short term liquidities shortfall).
If the quick ratio is still greater than 1, than that’s a sign that the company has short term liquidities lower than the industry, but that’s not such a bad thing.
I think map1 is right, this is in the CFAi texts, I just don’t remember what they said.
quick ratio doesn’t have inventory so it is a better sign.
It is quick ratio. Also because it is easy to compare to companies…if you take the current ratio you should also consider the inventory method utilized (FIFO or LIFO) and make adjustment…otherwise your comparison will be biased.
What??? Quick ratio has cash + marketable securities in the numerator. This excludes inventory and other working capital items. If you are concerned about working capital, why would you exclude it from the ratio? That makes no sense. That’s like saying that you want to analyze ROE, but doing so without common equity…
Wyantjs, you bring up a good point…if the question asks about working capital management, then we should analyze the current ratio, because WC = CA - CL. I honestly don’t have the answer, and I can believe both Current Ration and Quick Ratio because it sounds like the question is asking the analyst “what they would be most concerned about.” If the analyst is concerned, shouldn’t he go with the most conservative ratio…?
I am still for the quick ratio. As I have explained early, it is easy “quick” if you want to compare the WCM of two companies (assuming same industry)…if you take the current ratio you should also consider the inventory method utilized (FIFO or LIFO) and make adjustment…otherwise your comparison will be biased.
I suppose it is the current ratio that we should be most concerned about. If we talk about working capital we cannot exclude inventory from the analysis, regardless of the inventory method used… If we feel really concerned about differences we should adjust for the method but still take inventory into account. Plus, since the current ratio is less conservative than the quick ratio, if we have already a bad current ratio than it should imply an even worse quick ratio, which should mean that the current ratio is a matter of greater concern… i guess!
I think its about answering the question that’s asked. If you’re talking about working capital management then your investment in inventory is part of that answer. But if you really mean liquidity management, focusing on the quick ratio might be a better way to go.