Quick Ratio: A Measure of a Company’s Ability to Pay Its Immediate Liabilities
The quick ratio, also known as the acid-test ratio, is a financial metric used to evaluate a company’s short-term liquidity and its ability to cover immediate financial obligations. It’s a more stringent measure of liquidity compared to the current ratio because it excludes certain less liquid assets from the calculation.
Quick ratio formula
Quick Ratio = (Cash + Cash Equivalents + Marketable Securities + Accounts Receivable) / Current Liabilities
In this formula:
- Cash: The amount of cash on hand.
- Cash Equivalents: Highly liquid assets that are easily convertible to cash, such as short-term investments.
- Marketable Securities: Short-term investments that can be quickly converted to cash at their market value.
- Accounts Receivable: The amount of money owed to the company by its customers for goods or services provided on credit.
- Current Liabilities: Short-term financial obligations that the company needs to pay within a year, such as accounts payable, short-term loans, and other current liabilities.
The quick ratio provides insight into a company’s ability to cover its short-term liabilities using its most liquid assets. A higher quick ratio indicates a stronger ability to meet immediate financial obligations, while a lower quick ratio may suggest potential liquidity challenges.
It’s important to note that a “good” quick ratio can vary depending on the industry and the specific circumstances of the company. Comparing the quick ratio to industry benchmarks and historical performance can help provide a more meaningful assessment of a company’s liquidity position.
Current vs Quick ratio
If a company has a low quick ratio (1.5) but a high current ratio (2.5) it means that the company carries a large amount of inventory. What needs to be investigated is whether the inventory can be sold or converted into cash.