Quick ratio definition
The quick ratio measure of a company's ability to meet its short-term obligations using its most liquid assets (near cash or quick assets). Quick assets include those current assets that presumably can be quickly converted to cash at close to their book values. Quick ratio is viewed as a sign of a company's financial strength or weakness; it gives information about a company’s short term liquidity. The ratio tells creditors how much of the company's short term debt can be met by selling all the company's liquid assets at very short notice.
The quick ratio is also known as the acid-test ratio or quick assets ratio.
The quick ratio is calculated by dividing liquid assets by current liabilities:
Quick ratio = (Current Assets - Inventories) / Current Liabilities
Calculating liquid assets inventories are deducted as less liquid from all current assets (inventories are often difficult to convert to cash). All of those variables are shown on the balance sheet (statement of financial position).
Alternative and more accurate formula for the quick ratio is the following:
Quick ratio = (Cash and cash equivalents + Marketable securities + Accounts receivable) / Current Liabilities
The formula's numerator consists of the most liquid assets (cash and cash equivalents) and high liquid assets (liquid securities and current receivables).
To calculate the quick ratio, a company must first determine its quick (liquid assets. Quick assets are cash, marketable securities, and accounts receivable. The company must then calculate its current liabilities, which are liabilities due within one year, such as accounts payable and short-term debt. Once these figures have been calculated, the company can divide its quick assets by its current liabilities to find its quick ratio.
Quick ratio norms and limits
The higher the quick ratio, the better the position of the company. The commonly acceptable current ratio is 1, but may vary from industry to industry. A company with a quick ratio of less than 1 can not currently pay back its current liabilities; it's the bad sign for investors and partners.
The quick ratio is an important indicator of a company’s financial health. It can be used to assess a company’s liquidity, or its ability to pay off its short-term debt obligations. A higher quick ratio indicates that a company has sufficient quick assets to cover its current liabilities, while a lower quick ratio indicates that a company may not have enough liquid assets to meet its short-term obligations.
The quick ratio is also an important indicator of a company’s solvency. It shows how much of a company’s assets are liquid and how much are tied up in inventory and other non-liquid assets. If a company has a low quick ratio, it may not be able to pay off its short-term debt obligations.
The quick ratio is an important tool for lenders and investors, as it shows how well a company can meet its short-term debt obligations. It is also an important tool for companies, as it can be used to assess the risk of investing in a company or taking on debt. The quick ratio can be used to identify areas of potential risk. If a company has a low quick ratio, it may not have sufficient liquid assets to meet its short-term debt obligations. By monitoring a company’s quick ratio, it is possible to identify potential risks and take steps to reduce them.
Exact Formula in the ReadyRatios Analytic Software (based on the IFRS statement format).
Quick ratio = (F1[CashAndCashEquivalents]+ F1[OtherCurrentFinancialAssets]+ F1[TradeAndOtherCurrentReceivables])/ F1[CurrentLiabilities]
F1 – Statement of financial position (IFRS).
Average values for quick ratio you can find in our industry benchmarking reference book.
How to Improve Quick Ratio
There are several steps that can be taken to improve a company’s quick ratio. First, a company should review its current assets and liabilities to identify potential areas of improvement. For example, if a company has a low quick ratio, it may need to increase its quick assets or reduce its current liabilities.
Second, a company should review its debt structure to identify potential opportunities for improving its liquidity. For example, a company may be able to restructure its debt to reduce its interest payments or extend the repayment period.
Third, a company should review its accounts receivable to ensure that it is accurately reflecting the company’s current financial position. Accounts receivable should be reviewed and updated regularly to ensure that it is accurate and up-to-date.
Fourth, a company should review its inventory to identify potential opportunities for improving its liquidity. For example, a company may be able to reduce its inventory levels or increase its turnover rate to improve its liquidity.
Finally, a company should review its cash flow to identify potential opportunities for improving its liquidity. For example, a company may be able to reduce its operating expenses or increase its revenue to improve its liquidity.
Common Mistakes Calculating Quick Ratio
When calculating the quick ratio, it is important to avoid common mistakes. The most common mistake is to include inventories and other non-liquid assets in the calculation. Inventories and other non-liquid assets should not be included in the calculation, as they are not easily converted into cash.
Another common mistake is to include non-current liabilities in the calculation. Non-current liabilities, such as long-term debt, should not be included in the calculation, as they are not due within one year.
Finally, it is important to remember that the quick ratio should be calculated using the most recent financial information. If the financial information is not up-to-date, the quick ratio may not be an accurate measure of a company’s financial health.