Understanding quick ratio and how to use it.
Quick ratio, sometimes knows as the quick assets ratio or the acid test, is a way to identify and indicate a company’s short-term liquidity – its ability to meet it’s short-term obligations.
Quick ratio helps to measure a company’s ability to meet its short-term obligations with its most liquid assets. In this case, assets can include cash, accounts receivable, marketable securities, short-term investments and inventory. These assets are known as quick assets as they can easily and quickly be converted into cash.
Finance Terms
Key takeaways from this section:
- Quick ratio is a way of measuring a company’s ability to meet its short-term obligations with its most liquid assets.
- Quick ratio measures a company’s capacity to pay its current liabilities without needing to sell its inventory or have to obtain additional financing from elsewhere.
- To understand whether the quick ratio is good – the higher ratio results mean the company’s liquidity and financial health is good as opposed to a lower ratio.
- Quick ratio will differ for businesses in different sectors – some may have lower ratios on average whilst others will have a higher score. Always compare with what is considered to be the norm in your specific industry.
How to calculate the Quick Ratio
The formula for calculating quick ratio is:
QR = CE + MS + AR / CL
Where QR is quick ratio, CE is cash and equivalents, MS is marketable securities, AR is accounts receivable and CL is current liabilities.
For example, let’s say a company has £10m in cash, £20m in marketable securities, £25m in accounts receivable and £10m in accounts payable. By using the above formula, we can see that the company has a quick ratio of 5.5, which, simply put, means that it is able to pay its current liabilities 5.5 times over using its most liquid assets.
Any ratio that is greater than 1.0 means that company is in a good position and will be able to pay its liabilities. Anything under than 1.0 means that the company may have to resort to selling its inventory for example in order to pay its liabilities.
Another formula that can be used:
QR = CA – I – PE / CL
Where QR is quick ratio, CA is current assets, I is inventory and PE is prepaid expenses.
In order to accurately calculate the quick ratio, you can use your balance sheet to find the right assets to make the calculation.
Quick ratio FAQ's
What exactly is a quick ratio?
The quick ratio looks at the most liquid assets that a company has available and measures this against the amount of current liabilities the company has. Liquid assets refers to those assets that can be quickly converted into cash without impacting the actual price received in the open market.
The quick ratio is a way to measure the company’s ability to pay these short-term liabilities by having assets than can be quickly and easily converted into cash.
What assets are considered to be "quick"?
There are a number of different assets that are considered to be “quick”, these include cash, inventory, marketable securities, accounts receivable and some short-term investments. These are referred to as quick assets as they can be converted into cash quite quickly.
What's the difference between the quick ratio and other liquidity ratios?
The main difference between the quick ratio and other liquidity ratio is that the quick ratio only looks at the company’s most liquid assets, meaning it will give the most immediate picture if liquidity.
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