The Quick Ratio (QR) or often also Acid-Test Ratio (ATR) measures a company’s ability to pay Current Liabilities (CL) with its Current Assets (CA) – within 90 days or less.
CA also called Short-Term Assets are located on the balance sheet and represent the value of all assets that can reasonably expect to be converted into cash within one year. The following are examples of Current Assets used for QR:
- Cash and cash equivalents (Cash)
- Marketable securities or Short-Term Investments (STI)
- Accounts receivable (ST A/R)
CL also called Short-Term Liabilities are a company’s debts or obligations that are due within one year, also appearing on the company’s balance sheet. The following are examples of current liabilities:
- Short-term debt (STD)
- Accounts payables (ST A/P)
- Accrued liabilities and other debts
Calculating the Quick Ratio
Since the QR shows the proportion of CA to CL, it’s calculated by dividing CA by CL as shown in the formula below:
Let us see some results:
|less than 1||fewer CA than CL||Cash problem. High financial risk.|
|more than 1||more CA than CL||The Company is really liquid and as a result, could liquidate their CA within 90 days more easily to pay down their Short-Term Liabilities|
The Differences Between the CR and the QR
- The QR offers a more conservative view of a company’s liquidity or ability to meet its Short-Term Liabilities with its Short-Term Assets because it doesn’t include Inventory and other current assets that are more difficult to liquidate (i.e., turn into cash). By excluding inventory, and other less liquid assets, the QR focuses on the company’s more liquid assets.
- Since the CR includes inventory, it will be high for companies that are heavily involved in selling inventory. For example, in the retail industry, a store might stock up on merchandise leading up to the holidays, boosting their CR. However, when the season is over, the CR would come down substantially. As a result, the CR would fluctuate throughout the year for companies like retailers.
- How inventory is valued from an accounting standpoint would also impact the CR.
- On the other hand, removing inventory might not reflect an accurate picture of liquidity for some industries. For example, supermarkets move inventory very quickly, and their stock would likely represent a large portion of their CA. To strip out inventory for supermarkets would make their CL look inflated relative to their CA under the QR.
- Both ratios include accounts receivables, but some receivables might not be able to be liquidated very quickly. As a result, even the QR may not give an accurate representation of liquidity if the receivables are not easily collected and converted to cash.