What Is the Quick Liquidity Ratio?
The quick liquidity ratio is the total amount of a company’s quick assets divided by the sum of its net liabilities, and for insurance companies includes reinsurance liabilities. In other words, it shows how much easily-convertible-to-money assets, such as cash, short-term investments, equities, and corporate and government bonds nearing maturity, an insurance company can tap into on short notice to meet its financial obligations.
The quick liquidity ratio is also commonly referred to as the acid-test ratio or the quick ratio.
- The quick liquidity ratio is the total amount of a company’s quick assets divided by the sum of its net liabilities and reinsurance liabilities.
- This calculation is one of the most rigorous ways to determine a debtor's capacity to pay off current debt obligations without needing to raise external capital.
- The quick liquidity ratio is an important measure of an insurance company’s ability to cover its liabilities with relatively liquid assets.
- If an insurer has a high quick liquidity ratio, it’s in a better position to make payments than an insurer with a lower ratio.
How the Quick Liquidity Ratio Works
Investors have at their disposal several different liquidity ratios to assess a company’s ability to quickly and cheaply convert whatever assets it owns into cash. The quick liquidity ratio, which generally accounts only for resources that can be transformed into cash without losing value within 90 days, is widely considered to be one of the most stringent ways to determine a debtor's capacity to pay off current debt obligations without needing to raise external capital.
Quick liquidity ratios are usually expressed as a percentage. The higher the percentage, the more liquid and capable of paying off any money owed the company is.
A company with a low quick liquidity ratio that finds itself with a sudden increase in liabilities may have to sell off long-term assets or borrow money.
Example of the Quick Liquidity Ratio
The quick liquidity ratio is an important measure of an insurance company’s ability to cover its liabilities with relatively liquid assets.
Suppose an insurer covers a lot of property in Florida and then a hurricane strikes in the region. That insurer is now going to have to find more money than it would normally anticipate to pay claims. If such an insurer has a high quick liquidity ratio, it will be in a better position to make payments than an insurer with a lower ratio.
Quick Liquidity Ratio vs. Current Ratio
Like the quick liquidity ratio, the current ratio also measures a company's short-term liquidity, or ability to generate enough cash to pay off all debts should they become due at once. The quick liquidity ratio is deemed to be more conservative than the current ratio, though, because it takes fewer assets into consideration.
The quick liquidity ratio further refines the current ratio by measuring the level of the most liquid current assets available to cover current liabilities. It doesn’t include inventory and other assets such as prepaid expenses that are generally perceived as more difficult and slower to turn into cash.
That ultimately means quick liquidity ratios and current ratios can differ significantly. For instance, a company stocking lots of inventory could have a high current ratio and low quick liquidity ratio. Investors concerned about this company’s short-term liabilities might opt to dismiss the current ratio and focus more on the quick liquidity ratio, mindful that its inventory, though valuable, may be difficult to offload and turn into cash swiftly enough to settle a sudden hike in obligations.
A company that offers a mixture of different types of insurance policies is best compared to peers that offer a similar mixture, as opposed to comparing that company to insurers who only offer a specific and smaller range of products.
When evaluating a potential investment in an insurance company an investor should evaluate the types of plans that it offers, as well as how the company intends on covering its liabilities in the case of an emergency. The range of percentages considered “good” depend on the type of policies that an insurance company is providing. Property insurers are likely to have quick liquidity ratios greater than 30 percent, while liability insurers may have ratios above 20 percent.
In addition to evaluating the quick liquidity ratio, investors should look at a company’s current liquidity ratio, which shows how well it can cover liabilities with invested assets, and overall liquidity ratio, which shows how a company can cover liabilities with total assets.
Investors can also review operating cash flows (OCF) and net cash flows to determine how the company can meet its short-term liquidity needs from cash.