The Quick Ratio, sometimes called the “Acid-Test Ratio,” is a useful financial formula within the family of Liquidity Ratios. It juxtaposes a company’s quick assets and current obligations. This produces a number that reflects whether a business is able to cover its short-term debt with its near-cash assets.
The Quick Ratio Formula:
Quick Ratio = Quick Assets / Current Obligations
Quick assets: These are the parts of a company’s assets that are easily, or quickly accessible when financial obligations need to be paid. They include cash, cash equivalents, marketable securities, and accounts receivable. They do not include things like inventory, which need time to be sold in order to be converted into cash.
Current obligations: Also called Current liabilities, these are a company’s short-term financial obligations, due within one calendar year. Current liabilities can include accounts payable, short-term debt, dividends, and taxes owed, among other financial obligations.
What can the Quick Ratio tell me about my business?
If the quick ratio produces a number higher than 1, that indicates your business can easily pay off its short-term debt with the near-cash assets on hand. If it is under 1, then your current obligations cannot be easily paid off without converting other assets (such as inventory) into cash.
The quick ratio is an industry standard measure of liquidity. It is considered more conservative than the current ratio, because a normal company will have fewer quick assets than current assets available to cover debt in case of emergency.
Since quick ratio standards vary by industry, you should compare your quick ratio to the quick ratios of competitors and peers to establish whether you are within a healthy range.
Under this range indicates a less stable financial position, which may be a warning that you’ll have difficulty paying outstanding debts in a pinch. If you are much higher than your industry average, it can be indicative of an inefficient use of company assets.
Lenders and investors look at both the current and quick ratios in order to determine a company’s financial health. Be aware that a financially stable business is far more likely to get approved for loans or extensions of credit.