Quick Ratio

The quick ratio measures a company's ability to meet short-term obligations by converting current assets into cash. Learn more about this liquidity metric.

What is the Quick Ratio?

The quick ratio, also called the acid test ratio, measures a company’s ability to meet short-term financial obligations by converting current assets into cash. This accounting ratio is calculated by looking at three balance sheet accounts: current assets, inventory, current liabilities.

In order to build a stable business, it’s important to have enough cash and cash equivalents on hand to pay vendors and creditors. The quick ratio is a single number that executives, investors, lenders, and other stakeholders use to ensure the viability of a company.

If the quick ratio gets too low, a business might not have enough cash or cash equivalents on hand to keep the lights on. That said, a high ratio is not always better. Keeping too many quick assets might be a sign of inefficiency and hinder a company’s future growth.

The quick ratio formula is quick assets divided by current liabilities.

Quick Ratio Formula

The quick ratio formula is:

Quick Ratio = (Current Assets - Inventory) / Current Liabilities

Quick Ratio = Quick Assets / Current Liabilities

Like the current ratio, the denominator of the quick ratio is current liabilities. As a reminder, current liabilities are all liabilities that are due within one year. These can also be referred to as short-term liabilities”.

Furthermore, current assets minus inventory is also referred to as quick assets. Quick assets allow us to see a company’s ability to cover obligation with cash, marketable securities, and accounts receivable. It’s important to remember that many things (like fixed assets) could be sold at a steep loss in order to cover expenses, but those are not included in the quick ratio.

The quick ratio measures how a company covers its near-time essential business expenses without resorting to discounting assets significantly. For example, marketable securities and accounts receivable can quickly be converted to cash at their full value.

Examples of Quick Ratio

Here are two quick ratio examples that illustrate how to use the metric.

Company A

  • Cash: $100,000
  • Accounts Receivable: $35,000
  • Marketable Securities, including Treasury Bills: $35,000
  • Inventory: $50,000
  • Bills Payable: $30,000
  • Notes Payable: $40,000

Company B

  • Current Assets: $250,000
  • Inventory: $55,000
  • Current Liabilities: $90,000

These balance sheet accounts above will be used to calculate the quick ratio. However, we are given different information for both companies.

For Company A, we need to figure out which information goes where. Cash, accounts receivable, and marketable securities are quick assets while bills payable and notes payable are current liabilities. That means we can use this version of the formula:

Company A Quick Ratio = Quick Assets / Current Liabilities

Company A Quick Ratio = ($100,000 + $35,000 + $35,000) / ($30,000 + $40,000)

Company A Quick Ratio = $170,000 / $70,000

Company A Quick Ratio = 2.43x

For Company B, we are given the information we need to use the other form of the calculation:

Company B Quick Ratio = (Current Assets - Inventory) / Current Liabilities

Company B Quick Ratio = ($250,000 - $55,000) / $90,000

Company B Quick Ratio = 2.16x

As a reminder, cash is all the funds held in checking accounts, savings accounts, petty cash, and money orders. Marketable securities refers to treasury bills, commercial paper, money market funds, and public stock investments. These are referred to as “near cash” because they can quickly be converted to cash at the market price.

Current liabilities are obligations that must be repaid within the year. Examples of current liabilities include bills payable, accounts payable, notes payable, bank loans, taxes, and payroll (also called wages or salaries).

How is the Quick Ratio Used?

The quick ratio helps stakeholders understand the state of a company’s operations. For instance, is not a productive use of cash to sell your long-term assets to cover short-term expenses.

At a glance, a quick ratio below 1.0x tells us a company has more current liabilities than quick assets, which is not a good sign. A ratio this low implies that a business is not being efficiently run or is not generating enough profits.
A quick ratio of 1.0x means that quick assets is exactly equal to current liabilities, which is a better sign. Companies should strive to have a quick ratio above 1.0x, so that their short-term assets more than cover their short-term business expenses.

It’s important to maintain the right balance of high-return, long-term assets and short-term, low-return assets. This balance is a clear sign that the business resources are being put to productive use.

In closing, companies with a quick ratio above 1.0x are in a better position than companies with a lower ratio. But it is still possible for the quick ratio to be too high.

The quick ratio is one of three liquidity ratios, and it's not as strict as cash ratio or as lenient as current ratio.

How are Current Ratio and Quick Ratio Different?

Current ratio and quick ratio are measures of a company’s short-term liquidity. Here are the two formulas:

Current Ratio = Current Assets / Current Liabilities

Quick Ratio = (Current Assets - Inventory) / Current Liabilities

As you can see, the difference between current and quick ratio is that the quick ratio excludes inventory in its calculation. This is because inventory cannot be quickly sold at market value to cover accounts payable, bank loans, interest payments, or tax payments.

Both ratios are important to track, and will tell you slightly different things about a company’s solvency and liquidity. Note that in industries where there is no inventory (like some software companies), these ratios will always be the same.

How are the Cash Ratio and Quick Ratio Different?

Cash ratio is another liquidity metric. Here is the formula:

Cash Ratio = Cash Balance / Current Liabilities

Quick Ratio = (Current Assets - Inventory) / Current Liabilities

Like the name implies, the cash ratio looks at a company’s current cash position compared to its current liabilities. This differs from the quick ratio, which looks at cash, but other short-term assets like accounts receivable and marketable securities.

Final Thoughts

The quick ratio measures the ability for a company to cover its short-term obligations to vendors or creditors. The quick ratio formula is easy to calculate, and we recommend that businesses check the metric every month. The accounting ratio gets its name because it measures how much cash, or things that can quickly be converted to cash, a company has on hand.

Here is the summary:

  • Quick Ratio = (Current Assets - Inventory) / Current Liabilities
  • Quick Ratio = Quick Assets / Current Liabilities
  • The acid test ratio is another name for the quick ratio
  • Liquidity ratios are important because they ensure that a company has enough cash or cash equivalents to cover near-term bills from vendors and creditors

A company should monitor this liquidity ratio carefully. Too low of a quick ratio means a company could struggle to pay bills. Too high of a quick ratio means a company is keeping large amounts of cash and cash equivalents, which may be a sign of inefficiency.

Keep in mind that quick ratio does not look at a company’s long-term debt or relationship with long-term debtors. As a result, you could have a healthy quick ratio but still have an unsustainable financial structure ladened with debt that matures in 1+ years.

Quick ratio is considered a liquidity metric because it measures how many liquid assets a business has compared to its current liabilities. Companies measure liquidity closely because it helps them stay out of trouble, as falling behind on payments to creditors can put the company in a dangerous situation.

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