Current and quick

Q: What are “current” and “quick” ratios?

H.L., Lexington, Ky. A: They’re measures of liquidity, reflecting how easily a company may be able to meet its short-term obligations.

The current ratio is the simplest: Just divide current assets by current liabilities (both figures can be found on the latest balance sheet). The quick ratio is actually less quick to calculate, as it subtracts less-liquid assets (such as inventory and prepaid expenses) from current assets before dividing by current liabilities. There’s a third liquidity ratio, too — the “cash ratio.” It takes only the most liquid assets — cash and marketable securities — and divides them by current liabilities.

In general, each ratio should be 1 or more; ratios below that suggest the company may not be able to cover its immediate debts. However, an unusually high number may indicate a company not using its assets effectively. Current ratios will typically be higher than quick ratios, which will be higher than cash ratios. These figures can vary by industry, too, so it’s best to compare a company’s liquidity ratios with its peers — or with itself over time, to spot trends.

Q: How can a company’s earnings grow more slowly than its revenue?

M.M., Savannah, Ga.

A: They don’t necessarily grow at the same rate. For example, if a company’s revenue (also known as “sales,” and appearing at the top of its income statement) grows by 5% from one year to the next, but its costs increase by 30% (perhaps due to a tight supply of its raw materials), earnings growth will lag sales. But earnings that grow more quickly than revenue suggest increased efficiency and a growing profit margin.