Quick Ratio A Short Term Liquidity Metric, Formula, Example

Our company’s current ratio of 1.3x is not necessarily positive since a range of 1.5x to 3.0x is usually ideal, but it is certainly less alarming than a quick ratio of 0.5x. Similar to the current ratio, a company that has a quick ratio of more than one is usually considered less of a financial risk than a company that has a quick ratio of less than one. This capital could be used to generate company growth or invest in new markets. There is often a fine line between balancing short-term cash needs and spending capital for long-term potential. As a result of all such factors,  the company was able to increase its quick ratio significantly from 9 times to 12.6 times.

Such assets that can be converted into Cash in a very short period is called Quick Assets. Ideally, accountants and finance professionals should use multiple metrics to understand a company’s status. Due to different characteristics, some industries may have an average quick ratio that seems high or low. Note that while a quick ratio of one is generally good, whether your ratio is good or bad will depend on your industry. For example, a company with a low ratio might not be at too much of a risk if it has non-core fixed assets on standby that could be sold relatively quickly. Most often, companies may not face imminent capital constraints, or they may be able to raise investment funds to meet certain requirements without having to tap operational funds.

You’ll remember from Accounting 101 that assets are anything you own and liabilities are anything you owe. However, it’s essential to consider other liquidity ratios, such as current ratio and cash ratio when analyzing a great company to invest in. This way, you’ll get a clear picture of a company’s liquidity and financial health. Conversely, the current ratio factors in all of a company’s assets, not just liquid assets in its calculation.

  • As evident from the chart above, when we look at the quick ratio for ExxonMobil, a US-based multinational & gas company, we can see the ratio is in the range of 0.4 to 0.5 times.
  • It indicates that the company is fully equipped with exactly enough assets to be instantly liquidated to pay off its current liabilities.
  • The quick ratio is calculated by adding cash, cash equivalents, short-term investments, and current receivables together then dividing them by current liabilities.
  • It’s important to include other financial ratios in your analysis, including both the current ratio and the quick ratio, as well as others.
  • In publication by the American Institute of Certified Public Accountants (AICPA), digital assets such as cryptocurrency or digital tokens may not be reported as cash or cash equivalents.

Let us analyze how different are the ratios when compared with companies like Walmart and Home Depot. Generally, due to the tight working capital requirement, companies in the retail sector have a very low Quick ratio. Back in 2014, the ratio was 9.04 times which increased to 12.64 times in a matter of only 3 years. This means that for each dollar of Current liabilities, Walmart has only $0.18 worth of Quick assets which is really low. Below given is the Balance Sheet extract showing the total assets of Walmart. To understand the practical application of the ratio, let us calculate the Acid test ratio for Walmart in excel.

Both the current ratio and quick ratio measure a company’s short-term liquidity, or its ability to generate enough cash to pay off all debts should they become due at once. Although they’re both measures of a company’s financial health, they’re slightly different. The quick ratio is considered more conservative than the current ratio because its calculation factors in fewer items. The Quick Ratio, also known as the Acid-test or Liquidity ratio, measures the ability of a business to pay its short-term liabilities by having assets that are readily convertible into cash. These assets are, namely, cash, marketable securities, and accounts receivable.

What is the quick ratio?

Others may only consider liabilities due within the near future, typically the following six to 12 months. This will give you a better understanding of your liquidity and financial health. Or, on the other hand, the company may have more options to manage its debt than the quick ratio indicates.

This ratio is especially vital for accountants who create budgets, like certified management accountants. Improving your business’s quick ratio can make it easier to access funds and manage your financial obligations. But the quick ratio may not capture the profitability or efficiency of the company.

This liquidity ratio can be a great measure of a company’s short-term solvency. As an investor, you can use the quick ratio to determine if a company is financially healthy. “The higher the ratio result, the better a company’s liquidity and financial health is,” says Jaime. A quick ratio below 1 shows that a company may not be in a position to meet its current obligations because it has insufficient assets to be liquidated.

How to improve the quick ratio?

Though a company may be sitting on $1 million today, the company may not be selling a profitable good and may struggle to maintain its cash balance in the future. There are also considerations to make regarding the true liquidity of accounts receivable as well as marketable securities in some situations. On the other hand, a company could negotiate rapid receipt of payments from its customers and secure longer terms of payment from its suppliers, which would keep liabilities on the books longer. By converting accounts receivable to cash faster, it may have a healthier quick ratio and be fully equipped to pay off its current liabilities. The quick ratio uses only the most liquid current assets that can be converted to cash within 90 days or less. Note that liquid assets are considered here as assets that can be quickly converted to cash at a value close to their book values.

Why Is the Quick Ratio Better Than the Current Ratio?

More detailed analysis of all major payables and receivables in line with market sentiments and adjusting input data accordingly shall give more sensible outcomes which shall give actionable insights. There are numerous accounting ratios that can be used to determine the financial stability and credit-worthiness of your company. At the end of the forecast period, Year 4, our company’s ratio remains relatively unchanged at 0.5x, which is problematic as the concerns regarding short-term liquidity remain. Suppose a company has the following balance sheet financial data in Year 1, which we’ll use as our assumptions for our model. Quick assets refer to assets that can be converted into Cash within 90 days. Nonetheless, the company is able to maintain a steady-state quick ratio for the past 5 years.

A key point to note, though, is this isn’t a test to see how much debt a company has or if it could seek financing to cover any current debts. Rather, the quick ratio just looks at whether a company’s liquid assets outnumber its liabilities. The quick ratio measures how well a company can meet its short-term liabilities (such as debts payment, what is an invoice what is it used for payroll, inventory costs, etc.) with its cash on hand. In this case “cash” is defined as either actual cash or cash-like assets which can quickly be converted. Cash-like assets are traditionally defined as liquid properties that the company can easily sell off, such as stocks, or near-term revenue, such as accounts due for collection.

The quick ratio is similar to the current ratio but provides a more conservative assessment of the liquidity position of firms as it excludes inventory, which it does not consider as sufficiently liquid. If you’re looking for accounting software to help prepare your financial statements, be sure to check out The Ascent’s accounting software reviews. Other assets are excluded from the formula since it calculates your ability to pay debts short-term, so the formula is only concerned with assets that have liquidity. If the quick ratio for your business is less than 1, it means that your liabilities outweigh your assets, while a quick ratio of 10 means that for every $1 in liabilities, you have $10 in liquid assets. The company appears not to have enough liquid current assets to pay its upcoming liabilities. The quick ratio compares the short-term assets of a company to its short-term liabilities to evaluate if the company would have adequate cash to pay off its short-term liabilities.

Current Ratio Formula

In most companies, inventory takes time to liquidate, although a few rare companies can turn their inventory fast enough to consider it a quick asset. Prepaid expenses, though an asset, cannot be used to pay for current liabilities, so they’re omitted from the quick ratio. The quick ratio typically excludes prepaid expenses and inventory from liquid assets. Prepaid expenses aren’t included because the cash can’t be used to pay off other liabilities. Because this ratio seeks to tell how well a company can pay off immediate or pressing debts, inventory isn’t a reliable source.

The quick ratio measures a company’s ability to pay its short-term liabilities when they come due by selling assets that can be quickly turned into cash. It’s also called the acid test ratio, or the quick liquidity ratio because it uses quick assets, or those that can be converted to cash within 90 days or less. This includes cash and cash equivalents, marketable securities, and current accounts receivable. The quick ratio or acid test ratio is a liquidity ratio that measures the ability of a company to pay its current liabilities when they come due with only quick assets. Quick assets are current assets that can be converted to cash within 90 days or in the short-term. Cash, cash equivalents, short-term investments or marketable securities, and current accounts receivable are considered quick assets.

However, to maintain precision in the calculation, one should consider only the amount to be actually received in 90 days or less under normal terms. Early liquidation or premature withdrawal of assets like interest-bearing securities may lead to penalties or discounted book value. Now that we understand the complete know-how of the quick ratio, please go ahead and try calculating the quick ratio on your own in the Excel template made for you to practice. Please also analyze and see the reason for the increase/decrease in the quick ratio. (The quick ratio is used interchangeably with the acid test ratio. However, they will differ in certain situations).