Quick Ratio

AAA

DEFINITION of 'Quick Ratio'

An indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets. For this reason, the ratio excludes inventories from current assets, and is calculated as follows:

Quick ratio = (current assets – inventories) / current liabilities, or

                  = (cash and equivalents + marketable securities + accounts receivable) / current liabilities

The quick ratio measures the dollar amount of liquid assets available for each dollar of current liabilities. Thus, a quick ratio of 1.5 means that a company has $1.50 of liquid assets available to cover each $1 of current liabilities. The higher the quick ratio, the better the company's liquidity position. Also known as the “acid-test ratio" or "quick assets ratio."

INVESTOPEDIA EXPLAINS 'Quick Ratio'

For example, consider a firm with the following current assets on its balance sheet:

Cash $5 million, marketable securities $10 million, accounts receivable $15 million, inventories $20 million.

This is offset by current liabilities of $20 million.

The quick ratio in this case is 1.5 and the current ratio is 2.5.

The quick ratio is more conservative than the current ratio because it excludes inventories from current assets. The ratio derives its name presumably from the fact that assets such as cash and marketable securities are quick sources of cash. Inventories generally take time to be converted into cash, and if they have to be sold quickly, the company may have to accept a lower price than book value of these inventories. As a result, they are justifiably excluded from assets that are ready sources of immediate cash.

Whether “accounts receivable” is a source of ready cash is debatable, however, and depends on the credit terms that the company extends to its customers. A firm that gives its customers only 30 days to pay will obviously be in a better liquidity position than one that gives them 90 days. But the liquidity position also depends on the credit terms the company has negotiated from its suppliers. For example, if a firm gives its customers 90 days to pay, but has 120 days to pay its suppliers, its liquidity position may be reasonable.

The other issue with including accounts receivable as a source of quick cash is that unlike cash and marketable securities – which can typically be converted into cash at the full value shown on the balance sheet – the total accounts receivable amount actually received may be slightly below book value because of discounts for early payment and credit losses.

To learn more about assessing a company's liquidity, check out How do you calculate working capital?

VIDEO

Loading the player...
RELATED TERMS
  1. Overall Liquidity Ratio

    A measurement of a company’s capacity to pay for its liabilities ...
  2. Current Liquidity

    The total amount of cash and unaffiliated holdings compared to ...
  3. Quick Liquidity Ratio

    The total amount of a company’s quick assets divided by the sum ...
  4. Dollar Volume Liquidity

    A stock or exchange-traded fund's share price times its average ...
  5. Flight To Liquidity

    A situation where investors attempt to liquidate positions in ...
  6. Liquidity Coverage Ratio - LCR

    Highly liquid assets held by financial institutions in order ...
RELATED FAQS
  1. What measures can be used to evaluate the capital adequacy of a bank?

    The most commonly used assessment of a bank's capital adequacy is the capital adequacy ratio. However, many analysts and ... Read Full Answer >>
  2. How do unfunded capital expenditures and distributions affect the fixed charge coverage ...

    The most common solvency ratio is the solvency ratio itself, which measures a company's ability to meet all of its long-term ... Read Full Answer >>
  3. What are some alternative liquidity ratios to the cash ratio?

    There are other liquidity measures that can be used as an alternative to the cash ratio, including the current ratio and ... Read Full Answer >>
  4. What does the cash ratio of a company measure, and how does it affect decision making?

    The cash ratio of a company is used to measure the company's ability to pay off all of its current liabilities with only ... Read Full Answer >>
  5. What is the formula for calculating the quick ratio in Excel?

    The quick ratio is one of a number of measures of liquidity ratios used to determine a company's ability to pay off its short-term ... Read Full Answer >>
  6. How can a company quickly increase its liquidity ratio?

    A company’s liquidity ratio is a measurement of its ability to pay off all of its debts with its current assets. The ratio ... Read Full Answer >>
  7. What are the main income statement ratios?

    The following financial ratios are derived from common income statements and used to compare different companies within the ... Read Full Answer >>
  8. What are the main differences between the current ratio and the quick ratio?

    The current ratio is a financial ratio that investors and analysts use to examine the liquidity of a company and its ability ... Read Full Answer >>
  9. How do I measure option liquidity?

    An option is a financial instrument that gives the holder the right to purchase shares in a company at a certain set price ... Read Full Answer >>
Related Articles
  1. Fundamental Analysis

    The Value of Profitability Ratios

    How is a company being run? Is it generating profits? The answer to these questions lies in analyzing the profitability ratios of a company.
  2. Fundamental Analysis

    Measuring Company Efficiency

    Three useful indicators for measuring a retail company's efficiency are its inventory turnaround times, its receivables and its collection period.
  3. Investing Basics

    Understanding Leverage Ratios

    Large amounts of debt can cause businesses to become less competitive and, in some cases, lead to default. To lower their risk, investors use a variety of leverage ratios - including the debt, ...
  4. Markets

    What Is The Quick Ratio?

    Find out about this liquidity indicator and how it's used.
  5. Active Trading

    Understanding Liquidity Risk

    Make sure that your trades are safe by learning how to measure the liquidity risk.
  6. Options & Futures

    Understanding Financial Liquidity

    Understanding how this measure works in the market can help keep your finances afloat.
  7. Fundamental Analysis

    Dynamic Current Ratio: What It Is And How To Use It

    Learn why this ratio may be a good alternative to the current, cash and quick ratios.
  8. Forex Education

    8 Simple Investing Ratios You Need To Know

    Investing is a complex and often daunting experience, these equations are actually quite simple.
  9. Markets

    The Amateur Investor's Guide To Analyzing Corporate Efficiency

    Find out how the amateur investor can measure the success of management.
  10. Retirement

    Turnover Ratios Weak Indicator Of Fund Quality

    This indicator is not as important as some investors might think.

You May Also Like

Hot Definitions
  1. Treasury Yield

    The return on investment, expressed as a percentage, on the debt obligations of the U.S. government. Treasuries are considered ...
  2. Bund

    A bond issued by Germany's federal government, or the German word for "bond." Bunds are the German equivalent of U.S. Treasury ...
  3. European Central Bank - ECB

    The central bank responsible for the monetary system of the European Union (EU) and the euro currency. The bank was formed ...
  4. Quantitative Easing

    An unconventional monetary policy in which a central bank purchases private sector financial assets in order to lower interest ...
  5. Current Account Deficit

    A measurement of a country’s trade in which the value of goods and services it imports exceeds the value of goods and services ...
  6. International Monetary Fund - IMF

    An international organization created for the purpose of: 1. Promoting global monetary and exchange stability. 2. Facilitating ...
Trading Center
×

You are using adblocking software

Want access to all of Investopedia? Add us to your “whitelist”
so you'll never miss a feature!