Quick Ratio The quick ratio (or acid-test ratio) measures a company’s ability to meet short-term obligations using its most liquid assets. It focuses on assets that can be quickly converted to cash, offering a conservative view of short-term liquidity. Formula Quick Ratio = Quick Assets / Current Liabilities Explore More Resources
Common ways to calculate quick assets:
- Quick Assets = Cash + Cash Equivalents + Marketable Securities + Net Accounts Receivable
- Or: Quick Assets = Total Current Assets − Inventory − Prepaid Expenses Current liabilities include all debts and obligations due within one year (accounts payable, wages payable, current portions of long-term debt, taxes payable, etc.). Explore More Resources
Components (what is included)
* Cash: Bank balances and cash on hand.
* Cash equivalents: Short-term, highly liquid investments (e.g., Treasury bills, money market instruments).
* Marketable securities: Short-term investments readily sold at close to book value.
* Net accounts receivable: Accounts receivable less the allowance for doubtful accounts (only collectible amounts).
Note: Inventory and prepaid expenses are excluded because they are typically harder or impossible to convert to cash quickly. How to interpret the quick ratio
* Greater than 1.0: The company has more quick assets than current liabilities and can generally cover short-term obligations without selling inventory.
* Around 1.0: Quick assets roughly match current liabilities.
* Less than 1.0: The company may not be able to cover short-term obligations using only its most liquid assets.
A quick ratio of 1.5, for example, means $1.50 of quick assets for every $1 of current liabilities. Explore More Resources
Quick ratio vs. current ratio
* Quick ratio: Excludes inventory and prepaid expenses; more conservative.
* Current ratio: Includes all current assets (inventory, prepaid expenses); less conservative.
Use the quick ratio when you want an immediate liquidity check that ignores assets that aren’t readily converted to cash.
Advantages and disadvantages Advantages
- Conservative measure of liquidity.
- Simple to calculate from balance-sheet items.
- Useful for period-to-period or peer comparisons within industries. Disadvantages
- Ignores future cash flows and timing of receipts/payments.
- May overstate liquidity if receivables or securities are not easily collectible or marketable.
- Does not consider long-term obligations that may become due within 12 months. Explore More Resources
Quick example Suppose a company has:
- Cash: $100
- Cash equivalents: $50
- Marketable securities: $50
- Net accounts receivable: $100
- Current liabilities: $200 Quick assets = 100 + 50 + 50 + 100 = $300
Quick ratio = 300 / 200 = 1.5 Explore More Resources
Interpretation: The company has $1.50 in liquid assets for every $1 of short-term liabilities. What a low quick ratio can mean A low quick ratio can signal a potential liquidity problem: difficulty paying suppliers, employees, or short-term debt without selling inventory or raising external financing. In severe cases, inability to secure short-term funding can force asset fire sales or insolvency. Explore More Resources
Practical considerations
* Industry norms matter: Capital-intensive or inventory-heavy businesses often have lower quick ratios.
* Look at trends and related measures (current ratio, cash flow, receivables aging) rather than one ratio in isolation.
* Extremely high quick ratios may suggest inefficient use of cash that could be invested for growth.
Summary The quick ratio is a focused liquidity metric that shows how well a company can meet immediate obligations using only its most liquid assets. It’s a conservative, easy-to-calculate tool best used alongside other financial metrics and contextual industry benchmarks.