

Liquidity Measurement Ratios: Quick Ratio
By Richard Loth (Contact  Biography)
The quick ratio  aka the quick assets ratio or the acidtest ratio  is a liquidity indicator that further refines the current ratio by measuring the amount of the most liquid current assets there are to cover current liabilities. The quick ratio is more conservative than the current ratio because it excludes inventory and other current assets, which are more difficult to turn into cash. Therefore, a higher ratio means a more liquid current position.
Formula:
Components:
As of December 31, 2005, with amounts expressed in millions, Zimmer Holdings' quick assets amounted to $756.40 (balance sheet); while current liabilities amounted to $606.90 (balance sheet). By dividing, the equation gives us a quick ratio of 1.3.
Variations:
Some presentations of the quick ratio calculate quick assets (the formula's numerator) by simply subtracting the inventory figure from the total current assets figure. The assumption is that by excluding relatively lessliquid (harder to turn into cash) inventory, the remaining current assets are all of the moreliquid variety. Generally, this is close to the truth, but not always.
Zimmer Holdings is a good example of what can happen if you take the aforementioned "inventory shortcut" to calculating the quick ratio:
Standard Approach: $233.2 plus $524.2 = $756 ÷ $606.9 =1.3
Shortcut Approach: $1,575.6 minus $583.7 = $991.9 ÷ $606.9 = 1.6
Restricted cash, prepaid expenses and deferred income taxes do not pass the test of truly liquid assets. Thus, using the shortcut approach artificially overstates Zimmer Holdings' more liquid assets and inflates its quick ratio.
Commentary:
As previously mentioned, the quick ratio is a more conservative measure of liquidity than the current ratio as it removes inventory from the current assets used in the ratio's formula. By excluding inventory, the quick ratio focuses on the moreliquid assets of a company.
The basics and use of this ratio are similar to the current ratio in that it gives users an idea of the ability of a company to meet its shortterm liabilities with its shortterm assets. Another beneficial use is to compare the quick ratio with the current ratio. If the current ratio is significantly higher, it is a clear indication that the company's current assets are dependent on inventory.
While considered more stringent than the current ratio, the quick ratio, because of its accounts receivable component, suffers from the same deficiencies as the current ratio  albeit somewhat less. To understand these "deficiencies", readers should refer to the commentary section of the Current Ratio chapter. In brief, both the quick and the current ratios assume a liquidation of accounts receivable and inventory as the basis for measuring liquidity.
While theoretically feasible, as a going concern a company must focus on the time it takes to convert its working capital assets to cash  that is the true measure of liquidity. Thus, if accounts receivable, as a component of the quick ratio, have, let's say, a conversion time of several months rather than several days, the "quickness" attribute of this ratio is questionable.
Investors need to be aware that the conventional wisdom regarding both the current and quick ratios as indicators of a company's liquidity can be misleading.



Qualitative Analysis
Securities analysis that uses subjective judgment based on nonquantifiable ... 
Profit and Loss Statement (P&L)
A financial statement that summarizes the revenues, costs and ... 
Liquidity
The degree to which an asset or security can be quickly bought ... 
Profit Margin
Profit margin is part of a category of profitability ratios calculated ... 
Quarter  Q1, Q2, Q3, Q4
A threemonth period on a financial calendar that acts as a basis ... 
Debt Ratio
A financial ratio that measures the extent of a company’s or ...

Is the bottom line the best representation of a company's financial strength?
A company's bottom line, also referred to as net income, is an important indicator of operational condition and can be used ... Read Full Answer >> 
What is the formula for calculating the current ratio in Excel?
The current ratio is a metric used by the finance industry to assess a company's shortterm liquidity. It reflects a company's ... Read Full Answer >> 
How do you use Microsoft Excel to calculate liquidity ratios?
As with most Excel financial ratios, liquidity ratio calculations require at least two data points from outside financial ... Read Full Answer >> 
Does working capital include prepaid expenses?
The calculation for working capital includes any prepaid expenses that are due within one year, since such prepaid expenses ... Read Full Answer >> 
How do I read and analyze an income statement?
The income statement, also known as the profit and loss (P&L) statement, is the financial statement that depicts the ... Read Full Answer >> 
Why is working capital management important to a company?
Proper management of working capital is essential to a company’s fundamental financial health and operational success as ... Read Full Answer >>