Quick Ratio

The quick ratio is an accounting formula that measures a company's short-term liquidity. Also known as the "acid test" ratio, the quick ratio is a more stringent measurement than the current ratio of a company's ability to meet its most short-term obligations, usually those due within 90 days.

The formula for calculating the quick ratio is:

Quick Ratio = (Cash + Marketable Securities + Receivables)/Current Liabilities

Basically, the quick ratio measures a company's cash on hand and in the bank, plus any securities it can sell quickly and convert into cash, such as stocks or government securities, plus receivables it expects within the next 90 days. Then, the total from those figures is divided by any liabilities that come due in that time. The quick ratio is particularly important in assessing the liquidity of a company that may be under financial pressure in paying its bills.

Example Of A Quick Ratio

For example, let's say a company had total quick assets of US$2 million and US$1.5 million of current liabilities. Its quick ratio would be 1.3 (US$2 million/US$1.5 million = 1.3), indicating a fairly comfortable cushion to pay its most pressing liabilities. By contrast, if its quick assets totaled US$1.5 million and it had US$2 million in current liabilities, its quick ratio would be 0.75, which could be a warning signal.

Importantly, the quick ratio doesn't include inventories and supplies, which are generally less liquid and are included in the current ratio.[1] Likewise, prepayments, which are also included in the current ratio, are excluded from the quick ratio because they can't be easily reversed if the company needs that money in a crisis.

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A company's quick ratio should be examined within the context of its industry. A lower than average quick ratio may show that the company will have trouble paying its bills. Conversely, a higher than average figure may indicate some inefficiencies at the firm.

Summary

The quick ratio measures the ability of a company to meet its short-term obligations, and typically those due in the next 90 days. The quick ratio is calculated by dividing the company's cash, cash equivalents, marketable securities, and receivables by its current liabilities. The quick ratio is a more stringent measure of a company's ability to pay its bills than the current ratio, which also includes inventories and supplies and measures the company's ability to meet its obligations over the next year.

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References

1

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