Which ratio excludes inventory to provide a more conservative view of liquidity?

Which ratio excludes inventory to provide a more conservative view of liquidity?

• A. Asset turnover ratio
• B. Quick ratio
• C. Current ratio
• D. Cash ratio

Answer: (B)

When assessing short-term financial health, you want to know if the company can meet obligations with assets that can be turned into cash quickly. The quick ratio does this by removing inventory (and prepaid expenses) from current assets, leaving cash, marketable securities, and receivables in the numerator. Since inventory can be slow to liquidate, excluding it gives a more conservative view of liquidity—you’re measuring the ability to cover current liabilities without counting on converting inventory promptly. The current ratio includes inventory, which can overstate liquidity, while the cash ratio is even more conservative but uses only cash and cash equivalents.

When assessing short-term financial health, you want to know if the company can meet obligations with assets that can be turned into cash quickly. The quick ratio does this by removing inventory (and prepaid expenses) from current assets, leaving cash, marketable securities, and receivables in the numerator. Since inventory can be slow to liquidate, excluding it gives a more conservative view of liquidity—you’re measuring the ability to cover current liabilities without counting on converting inventory promptly. The current ratio includes inventory, which can overstate liquidity, while the cash ratio is even more conservative but uses only cash and cash equivalents.