What Is the Quick Ratio?

The quick ratio measures a company’s ability to immediately meet its short-term obligations using its most liquid assets. The quick ratio is used to evaluate the strength of a company's cash position.

The quick ratio is sometimes called the 澳洲幸运5开奖号码历史查询:acid test ratio.

Formula for the Quick Ratio

There are a few different ways to calculate the quick ratio. The most common approach is to add the most liquid assets and divide the total by🍷 current liabilities:

$\begin{aligned}&\textbf{Quick Ratio}\mathbf{=}\frac{\textbf{``Quick Assets''}}{\textbf{Current Liabilities}}\end{aligned}$​Quick Ratio=Current Liabilities“Quick Assets”​​

Quick assets are defined ♐as the most liquid current assets that can easily be exchanged for cash. For most compa♍nies, quick assets are limited to just a few types of assets:

$\begin{aligned}&\textbf{Quick Assets}\mathbf{=}\textbf{Cash}\mathbf{+}\textbf{CE}\mathbf{+}\textbf{MS}\mathbf{+}\textbf{NAR}\\&\textbf{where:}\\&\text{CE}=\text{Cash equivalents}\\&\text{MS}=\text{Marketable securities}\\&\text{NAR}=\text{Net accounts receivable}\end{aligned}$​Quick Assets=Cash+CE+MS+NARwhere:CE=Cash equivalentsMS=Marketable securitiesNAR=Net accounts receivable​

Depending on what type of current assets a company has on its balance sheet, a company may also calculate quick assets by deducting illiquid current assets from its 澳洲幸运5开奖号码历史查询:balance sheet. For example, consider that inventory and prepaid expe🧸nses may not be easily or quickly converted to cash; a company may calculate quick assets as follows:

$\begin{aligned}&\textbf{Quick Assets}\mathbf{=}\textbf{TCA}\mathbf{-}\textbf{Inventory}\mathbf{-}\textbf{PE}\\&\textbf{where:}\\&\textbf{TCA}=\text{Total current assets}\\&\textbf{PE}=\text{Prepaid expenses}\end{aligned}$​Quick Assets=TCA−Inventory−PEwhere:TCA=Total current assetsPE=Prepaid expenses​

Regardless of which method is used to calculate quick assets, the calculation for current liabilities is the same, as all current liabilities are included in the formula.

What the Quick Ratio Can Tell You

The quick r✃atio measures the dollar amount of liquid assets available against the dollar amount of current liabilities of a company.

澳洲幸运5开奖号码历史查询:Liquid assets are those 澳洲幸运5开奖号码历史查询:current assets that can be quickly converted into cash with minimal impact on the price received in the open market, while 澳洲幸运5开奖号码历史查询:current liabilities are a company’s debts or obligations that are due to be paid to creditors within one year.ꦚ

A company that has a quick ratio of less than one may not be able to fully pay off its current liabilities in the short term, while a com𝓀pany having a quick ratio higher than one can instantly get rid of its current liabilities.

For instance, a quick ratio of 1.5 indicates thꦦat a company has $1.50 of liquid assets available to cover each $1 of its current liabilities.

While such 澳洲幸运5开奖号码历史查询:numbers-based ratios offer insight into the viability and certain aspects of a business, they may not provide a complete picture of the overall health of the business. It is important to look at other associated measures to assess the true picture of a company’s﷽ financial health.

Components of the Quick Ratio

Cash

Cash is among the more straightforward pieces of the quick ratio. A company should strive🌱 to reconcile it🃏s cash balance to monthly bank statements received from its financial institutions. This cash component may include cash from foreign countries translated to a single denomination.

Cash Equivalents

Cash equivalents are often an extension of cash, as this account often houses investments with very low risk and high liquidity. Cash equivalents often include but may not necessarily be limited to Treasu🅺ry bills, certificates of deposits (being mindful of options/fees to break the CD), bankers’ acceptances, corporate commercial paper, or other money market instruments.

In a publication by the American Institute of Certified Public Accountants (AICPA), digital assets such as cryptocurrency or digital tokens may not be reported as cash or cash equivalents.

Marketable Securities

Marketable securities are usually free from such time-bound dependencies. However, to maintain precision in the calculation, one should consider only the amount to be actually received in 90 days or less under normal terms. Early liquidation or premature with💞drawal of assets like interest-bearing securities may lead to penalties or discounted book value.

Net Accounts Receivable

Whether 澳洲幸运5开奖号码历史查询: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.

On the other hand, a company could negotiate the rapid receipt of payments from its customers and secure longer terms of payment from its suppliers, which would keep liabilities on the books longer. By converting accounts receivable to cash faster, it may have a healthier quick ratio and be fully equipped to pay off its current liabilities.

The total accounts receivable balance should be reduced by tꦗhe 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 that a company does not expect to receive.

Current Liabilities

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 h🧸ave 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.

Quick Ratio vs. Current Ratio

The quick ratio is more conservative than the current ratio because it excludes inventory and other currenꦓt assets, which are generally more difficult to turn into cash.&nb꧋sp;

The quick ratio considers only assets that can be converted to cash in a short period of time. The current ratio, on the other hand, considers inventory and ൩prepaid expense assets.

In most companies, 澳洲幸运5开奖号码历史查询:inventory takes time to liquidate, although a few rare companies can turn their inventory fast enough to consider it a quick asset. 澳洲幸运5开奖号码历史查询:Prepaid expenses, though an asset, cannot be used to pay for current liabilities, so they’re omitted🦹 from the quick ra🦄tio.

Advantages and Disadvantages of the Quick Ratio

Advantages

The quick ratio has the advantage of being a more conservative estimate of how liquid a company is. Compared to other calculations that include potentially illiquid assets, the quick ratio is oℱften a better true indicator of short-term cash capabilities.

The quick ratio is also fairly easy and straightforward to calculate. It’s relatively easy to understand, especially when comparing a company’s liquidity against a target calculation such as 1.0. The quick ratio can be used to analyze a single company over a period of time or can be used to compare similar compani♏es.

Disadvantages

There are several downsides to ไthe quick ratio. The financial metric does not giveꦓ any indication of a company’s future cash flow activity. Though a company may be sitting on $1 million today, the company may not be selling a profitable product and may struggle to maintain its cash balance in the future.

There are also considerations to make regarding the true liquidity of accounts receivable as well as marketable secu♔rities in some situations.

Example of How to Use the Quick Ratio

Publicly traded companies may report the quick ratio figure under the “Liquidity/Fina♒ncial Health” heading in the “Key Ratios” section of their quarterly ꦿreports.

Below is the calculation of the quick ratio based on the figures that appear on the balance sheets of two leading competit𒐪ors operating in the personal care industrial sector, ABC and XYZ.

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. ABC, on the other hand, may not be able to pay off its current obligations using only quick assets, as its quick ratio is well below 1, at 0.45.

This shows that, disregarding pr🦩ofitability or income, XYZ appears to be in better short-term financial health regarding its ability to m♏eet its short-term debt requirements.

The Bottom Line

A company can’t exist without 澳洲幸运5开奖号码历史查询:cash flow and the ability to pay its bills as they come due. By measuring 🐼its quick ratio, a company can better understand what resources it has in the very short term in case it needs to liquidate current assets.

Though💯 other liquidity ratios measure a company’s ability to be solvent in the short term, the quick ratio is among the most 🎐aggressive in deciding short-term liquidity capabilities.