Quick Ratio Definition, Formula & Examples

The quick ratio is a metric which measures a firm’s ability to pay its current debts without selling additional inventory or raising additional capital. It is calculated as the dollar value of a firm’s “quick” assets (cash equivalents, securities, and receivables), divided by the firm’s current debt. The quick ratio is often compared to the cash ratio and the current ratio, which include different assets and liabilities. In contrast to liquidity ratios, solvency ratios measure a company’s ability to meet its total financial obligations and long-term debts. Solvency relates to a company’s overall ability to pay debt obligations and continue business operations, while liquidity focuses more on current or short-term financial accounts. The importance of the quick ratio lies in its ability to give insight into a company’s financial health and its ability to meet its short-term obligations.

One key difference between the quick and current ratios is including inventory in the latter. Inventory can be a significant component of a company’s current assets, but converting inventory into cash is not always easy. As a result, the quick ratio is considered a more conservative measure of liquidity because it excludes inventory from the calculation. First, we need to identify the company’s current assets, which include cash, cash equivalents, accounts receivable, and any other assets that can be easily converted into cash. We then subtract the value of inventory and prepaid expenses from current assets. This is because inventory and prepaid expenses are less liquid than other assets and may take longer to convert into cash.

How Does Liquidity Differ From Solvency?

This is because accounts receivable are typically more liquid than inventory and can be quickly converted into cash. On the other hand, a quick ratio of 1.0 is considered a more robust level of liquidity, as it indicates that a company has enough liquid assets to cover its short-term debts without relying on inventory. When analyzing a company’s financial health, quick and current ratios are necessary liquidity measures. While similar, some key differences between the two ratios are worth exploring.

This means they don’t consider the dynamic nature of business operations and cash flows. For example, the current ratio may indicate sufficient liquidity based on current assets and liabilities, but it doesn’t account for the timing of cash inflows and outflows. A company with high receivables and inventory turnover may have a healthy current ratio but struggle to convert these assets into cash quickly when needed.

Why is knowing the quick ratio important?

The profits from business expansion only appear as balance sheet assets many years down the line. The current ratio measures a company’s ability to pay current, or short-term, liabilities (debt and payables) with its current, or short-term, assets (cash, inventory, and receivables). The quick ratio is a more conservative measure of liquidity than the current ratio, because it doesn’t include all of the items used in the current ratio. The quick ratio, often referred to as the acid-test ratio, includes only assets that can be converted to cash within 90 days or less. For example, a quick ratio of 1.0 would indicate the company has exactly the amount of liquid assets necessary to pay its current liabilities. Liquidity ratios are simple yet powerful financial metrics that provide insight into a company’s ability to meet its short-term obligations promptly.

Solutions include clear communication, trust-based leadership, fostering connection, flexible scheduling, knowledge sharing, nurturing well-being, and anticipating future trends in remote team management. Although a quick ratio of one or higher is desirable, you shouldn’t panic if your quick ratio is less than one. You also shouldn’t become too complacent if your quick ratio is two or higher. It’s important to take all factors of your business into consideration before determining if your quick ratio is too low, too high, or just right.

Why Are There Several Liquidity Ratios?

Before proceeding, it’s worth noting that many of these terms have precise financial meanings, which might differ from their commonsense usage. Charlene Rhinehart is a CPA , CFE, chair quick ratio is another commonly used term for the of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University. The following figures have been taken from the balance sheet of GHI Company.

• It’s important to remember that just because a company has a sizable inventory, it doesn’t mean these assets can be easily or swiftly monetized.
• As a result, the ratio of debt to tangible assets—calculated as ($50/$55)—is 0.91, which means that over 90% of tangible assets (plant, equipment, and inventories, etc.) have been financed by borrowing.
• Financial leverage, however, appears to be at comfortable levels, with debt at only 25% of equity and only 13% of assets financed by debt.
• This means they don’t consider the dynamic nature of business operations and cash flows.
• As a business owner or investor, it’s crucial to understand financial ratios, particularly those that relate to a company’s liquidity.
• A low quick ratio indicates that a company has a low level of liquid assets relative to its short-term liabilities.

In addition to these factors, a low quick ratio can also be influenced by industry-specific factors, such as seasonal fluctuations or inventory turnover. For example, companies in the retail industry may have lower quick ratios due to their high levels of inventory, which can take longer to convert into cash. Analysts also use the quick ratio to compare a company’s liquidity to its peers or industry benchmarks, providing additional insights into its financial performance. For example, suppose a company has a high level of inventory that can be quickly sold and converted into cash. In that case, the Current Ratio may be a more appropriate measure of liquidity.

Sell Non-Essential Assets –  Improving Quick Ratio

But sometimes customers don’t pay their bills (i.e., they default), and recovering debts from bankrupt or fraudulent businesses can be a costly, drawn-out process. This suggests that Apple has liquid assets worth about 17% more than its current debts (i.e., $1.17 of liquid assets for every $1.00 of current debt), which puts it in a healthy liquidity position. The total accounts receivable balance should be reduced by the estimated amount of uncollectible receivables. As the quick ratio only wants to reflect the cash that could be on hand, the formula should not include any receivables a company does not expect to receive. The current ratio will usually be easier to calculate because both the current assets and current liabilities amounts are typically broken out on external financial statements. As seen in the example above, it is important to consider not just the quick ratio, but also other relevant ratios such as the current ratio when assessing a company’s liquidity.

• Although solvency does not relate directly to liquidity, liquidity ratios present a preliminary expectation regarding a company’s solvency.
• A company must have more total assets than total liabilities to be solvent; a company must have more current assets than current liabilities to be liquid.
• There are also considerations to make regarding the true liquidity of accounts receivable as well as marketable securities in some situations.
• In other words, Jim could pay off all of his current liabilities with only 66% of his quick assets.
• Even if a company’s assets are dominated by receipts, if they come in at a uniform rate that is faster than the speed at which bills come due, the company’s financials are probably sound.
• Whether a company has to pay back a loan or settle an invoice from a supplier, its quick ratio can reveal if it’s equipped to do so.

He is a CFA charterholder as well as holding FINRA Series 7, 55 & 63 licenses. He currently researches and teaches economic sociology and the social studies of finance at the Hebrew University in Jerusalem. A financial professional will offer guidance based on the information provided and offer a no-obligation call to better understand your situation. The articles and research support materials available on this site are educational and are not intended to be investment or tax advice. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly. 11 Financial may only transact business in those states in which it is registered, or qualifies for an exemption or exclusion from registration requirements.