Which statement about liquidity ratios is correct?

• A. Current ratio equals current assets divided by current liabilities; quick ratio equals (cash plus receivables plus short-term investments) divided by current liabilities.
• B. Current ratio excludes inventory.
• C. Higher ratios indicate weaker short-term liquidity.
• D. Quick ratio includes inventory in the numerator.

Answer: (A)

Liquidity ratios measure a firm's ability to meet short-term obligations. The current ratio is calculated as current assets divided by current liabilities. The quick ratio is a more conservative measure, using only cash plus receivables plus short-term investments in the numerator, divided by current liabilities. This is why the described statement is correct: it correctly defines both ratios and their components. Remember, current assets include inventory, so the current ratio does include inventory. A higher ratio indicates stronger, not weaker, short-term liquidity. The quick ratio, by excluding inventory, does not include inventory in the numerator.