Definition of 'Quick Ratio'
Quick ratio is the result signifying a company’s short-term liquidity, demonstrating whether the company can address immediate financial obligations such as debt and other business expenses.
TheStreet Explains ‘Quick Ratio’
Quick ratio does not include inventory from current assets and is based on immediately accessible assets such as cash or inventories that can be instantly liquidated into cash. Sometimes referred to as the acid test ratio, the quick ratio can be calculated as:
Quick ratio = (current assets - inventories)/current liabilities
Quick ratio is a similar (but different) aspect of the current ratio. The current ratio goes a little deeper because it investigates into whether the company can pay current liabilities with existing or available assets. Both ratios are vital to helping businesses stay viable with the higher the quick ratio the better.
For example, Mary’s Dog Spa and Hotel currently has $60,000 in cash, along with $10,000 in marketable securities. Accounts receivable is $40,000 and she has $65,000 in current liabilities. After plugging these numbers into the formula Mary can assume her quick ratio is 1.7, which means Mary has $1.70 in liquid assets that she can use immediately (for debt, salaries, etc.).
Companies with a quick ratio over 1.0 are considered to be able to meet immediate debt obligations. Why might a company drop below 1.0? Reasons include allowing money to flow out quickly (paying bills immediately, etc.) but not collecting receivables in the same fashion can wreck havoc with your quick ratio. Also, companies who cannot generate enough in sales or have taken on far too much debt may be in quick ratio trouble.
While commonly used, business owners should know a quick ratio cannot determine cash flow level and timing. Also, accounts receivable availability is assumed when using the quick ratio, which may not always be the case. Additionally, the ratio also assumes the company would liquidate assets to pay liabilities if cash was not currently available--this may not always be the case.
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