Quick ratio – What is the quick ratio?
The quick ratio, also known as the acid-test ratio, is a liquidity ratio that measures the ability of an individual or business to pay for current liabilities and short-term expenses.
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Whereas the current ratio includes all current assets and current liabilities, the quick ratio only considers ‘quick assets’. Quick assets are the most easily liquidated assets, meaning that they can be converted into cash within a short period of time.
The quick ratio therefore considers cash and cash equivalents, marketable securities and accounts receivable, but does not consider inventory. Inventory is not included in the quick ratio because is it generally more difficult to sell or turn into cash.
The quick ratio is:
(Cash equivalents + marketable securities + accounts receivables) ÷ current liabilities
How to use the quick ratio
The higher the quick ratio, the higher the liquidity. As a general rule, a quick ratio greater than 1.0 indicates that a business or individual is able to meet their short-term obligations.
A low or decreasing ratio generally indicates that:
- The company has taken on too much debt;
- The company’s sales are decreasing;
- The company is struggling to collect accounts receivable;
- The company is paying its bills too quickly.
The ratio is most useful for companies within in manufacturing and retail sectors where inventory can comprise a large part of current assets. It is often used by prospective creditors or lenders to find out whether the company will be able to pay their debts on time.
Quick ratio vs. current ratio
Compared to the current ratio, the quick ratio is seen as a more refined and conservative way of measuring liquidity. Because the quick ratio only considers the most liquid assets, it can give a better overview of the ability of a company to pay for its short-term liabilities.
However, the quick ratio may still not be an accurate or realistic indicator of immediate liquidity, as companies cannot always liquidate the current assets included in the quick ratio. The quick ratio may be particularly unsuitable for companies which have longer payment terms.