What Is Quick Ratio? Importance, Formula, Example, and Pros

The quick ratio or acid test ratio is a liquidity ratio that measures the ability of a company to pay its current liabilities when they come due with only quick assets. Quick assets are current assets that can be converted to cash within 90 days or in the short-term. Cash, cash equivalents, short-term investments or marketable securities, and current accounts receivable are considered quick assets. The cafeteria plans will calculate the quick ratio of any company if you enter in the current assets, current inventory, and the current liabilities of the company. The Quick Ratio, also known as the acid-test ratio, is a financial metric used to evaluate a company’s ability to meet its short-term liabilities with its most liquid assets. Unlike the current ratio, the quick ratio excludes inventory from assets, providing a more stringent test of liquidity.

Formula For Quick Ratio

Unlike the quick ratio, it includes all current assets—including inventory—in the calculation. Therefore, the current ratio could provide a more lenient view of a company’s liquidity compared to the quick ratio. The quick ratio pulls all current liabilities from a company’s balance sheet, as it does not attempt to distinguish between when payments may be due. The quick ratio assumes that all current liabilities have a near-term due date. Total current liabilities are often calculated as the sum of various accounts, including accounts payable, wages payable, current portions of long-term debt, and taxes payable. With a quick ratio of over 1.0, XYZ appears to be in a decent position to cover its current liabilities, as its liquid assets are greater than the total of its short-term debt obligations.

• The quick ratio also holds more value than other liquidity ratios, such as the current ratio, because it has the most conservative approach to reflecting how a company can raise cash.
• This discrepancy can lead to interesting insights in financial analysis.
• It includes anything convertible to cash almost immediately, such as bank balances and checks.
• In other words, the quick ratio allows you to determine whether or not a company has enough resources to fulfill its obligations that are due within a year.

Quick assets

Since it indicates the company’s ability to instantly use its near-cash assets (assets that can be converted quickly to cash) to pay down its current liabilities, it is also called the acid test ratio. An “acid test” is a slang term for a quick test designed to produce instant results. The Quick Ratio excludes inventory from current assets, while the Current Ratio includes inventory.

Company

If there’s a cash shortage, you may have to dig into your personal funds to pay employees, lenders, and bills. Startup businesses generally have a lower quick ratio compared to more mature businesses, because the startups typically have more debt. This could be perfectly normal given their respective business models. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. 11 Financial is a registered investment adviser located in Lufkin, Texas.

By converting accounts receivable to cash faster, it may have a healthier quick ratio and be fully equipped to pay off its current liabilities. Whether accounts receivable is a source of quick, ready cash remains a debatable topic, and it depends on the credit terms that the company extends to its customers. A company that needs advance payments or allows only 30 days for customers to pay will be in a better liquidity position than a company that gives 90 days. For instance, a quick ratio of 1.5 indicates that a company has $1.50 of liquid assets available to cover each $1 of its current liabilities.

A firm’s short-term liabilities include accounts payable, short-term loans, income tax due, and accrued expenses that the organization has yet to pay off. Accrued expenses can include any fraction of a long-term loan that is due for repayment within the next 12 months. A company may have a higher current ratio, especially if it carries a lot of inventory. Accounts payable, or trade payables, reflect how much you owe suppliers and vendors for purchases. For example, if you have a five-year loan for a vehicle, the next 12 months of payments will be a current liability. The quick ratio is useful when analyzing a company’s liquidity position.

While usually accurate, this approximation does not always represent the total liquidity of the firm. The current ratio also includes less liquid assets such as inventories and other current assets such as prepaid expenses. The quick ratio formula is quick assets divided by current liabilities.

However, the flour and sugar stored in the back, despite being essential for running the bakery, aren’t as liquid. They can’t be sold off as quickly or easily as the ready-to-go bread and pastries. If new financing cannot be found, the company may be forced to liquidate assets in a fire sale or seek bankruptcy protection. There are also considerations to make regarding the true liquidity of accounts receivable as well as marketable securities in some situations. Cash is among the more straightforward pieces of the quick ratio.

Financial ratios are based on a given income statement and balance sheet. And in a dynamic world, we have to supplement the financial statement given at a point in time with a trend analysis of changes that have occurred over time. For example, inventories may take several months to sell; also, prepaid expenses only serve to offset otherwise necessary expenditures as time elapses. Keep in mind that a very high quick ratio may not be better.