Quick ratio

Definition

The quick ratio, also known as the acid-test ratio, is a financial metric used to evaluate a company’s short-term liquidity position.

What is a quick ratio?

A quick ratio measures the firm’s ability to cover its immediate or short-term liabilities using its most liquid assets. This ratio is a crucial indicator of a company’s ability to meet its immediate financial obligations without relying on the sale of inventory or other potentially less liquid assets.

The formula for calculating the quick ratio is:

Quick ratio = quick assets / current liabilities

A quick ratio of 1 or higher indicates that a company has enough quick assets to cover its current liabilities, which is generally considered a sign of good short-term financial health. On the other hand, a quick ratio below 1 suggests that the company may face difficulty in meeting its short-term obligations with its readily available liquid assets alone.

The quick ratio is a valuable tool for investors, creditors, and analysts when assessing a company’s financial health, particularly in industries or situations where short-term cash flow management is critical. However, it’s important to use this ratio in conjunction with other financial metrics for a comprehensive evaluation of a company’s overall financial condition.

Example of a quick ratio

Company ABC has the following assets and liabilities:

Quick assets:

• Cash: R20,000
• Marketable securities: R10,000
• Accounts receivable: R15,000

Current liabilities:

• Accounts payable: R12,000
• Short-term debt: R8,000

To calculate the quick ratio we use the formula from above:

Quick ratio = (R20,000 + R10,000 + R15,000) / (R12,000 + R8,000)

Quick ratio = R45,000 / R20,000  = 2.25

In this example, Company ABC’s quick ratio is 2.25. This means that the company has R2.25 in quick assets for every R1 in current liabilities, indicating a healthy liquidity position.