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

RELATED TERMS
  1. Accounts Receivable - AR

    Money owed by customers (individuals or corporations) to another ...
  2. Acid-Test Ratio

    A stringent indicator that determines whether a firm has enough ...
  3. Working Ratio

    A ratio used to measure a company's ability to recover operating ...
  4. Current Assets

    1. A balance sheet account that represents the value of all assets ...
  5. Current Liabilities

    A company's debts or obligations that are due within one year. ...
  6. Current Ratio

    A liquidity ratio that measures a company's ability to pay short-term ...
Related Articles
  1. Personal Finance

    What are the main income statement ratios?

  2. How is a company being run? Is it generating profits?
    Fundamental Analysis

    The Value of Profitability Ratios

  3. Fundamental Analysis

    Measuring Company Efficiency

  4. Investing Basics

    What are the main differences between ...

Hot Definitions
  1. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  2. Conduit Issuer

    An organization, usually a government agency, that issues municipal securities to raise capital for revenue-generating projects ...
  3. Financing Entity

    The party in a financing arrangement that provides money, property, or another asset to an intermediate entity or financed ...
  4. Hyperinflation

    Extremely rapid or out of control inflation. There is no precise numerical definition to hyperinflation. Hyperinflation is ...
  5. Gross Rate Of Return

    The total rate of return on an investment before the deduction of any fees or expenses. The gross rate of return is quoted ...
  6. Debit Spread

    Two options with different market prices that an investor trades on the same underlying security. The higher priced option ...
Trading Center