Final answer:
The quick ratio is a more stringent measure of a company's short-term solvency than the current ratio since it only includes cash and other highly liquid assets in its calculations, removing inventories and prepaid expenses which are not as quickly convertible to cash. The correct option is 3.
Step-by-step explanation:
The quick ratio is a more rigorous test of short-run solvency than the current ratio because it provides a conservative view of a company's ability to meet its short-term liabilities. The quick ratio, also known as the acid-test ratio, takes into account only the most liquid assets, which are those that can be quickly converted into cash without a significant loss of value. This is why the quick ratio is content loaded with conditions:
- The quick ratio eliminates inventories from the numerator because inventories may not be readily converted to cash and may have to be sold at a discount.
- The quick ratio eliminates prepaid expenses from the numerator because these are not convertible to cash and represent services or benefits to be received in the future.
- The quick ratio considers only cash and marketable securities as current assets, as these are the assets that can be most quickly used to settle debts.
Therefore, while the current ratio includes all current assets in the calculation, the quick ratio provides a more stringent measure by focusing only on those assets with high liquidity.