The quick ratio, also known as acid-test ratio, is a financial ratio that measures liquidity using the more liquid types of current assets. Its computation is similar to that of the current ratio, only that inventories and prepayments are excluded.
The quick ratio (or acid-test ratio) is a more conservative measure of liquidity than the current ratio. The formula for quick ratio is:
Quick ratio = Quick assets ÷ Current liabilities
Quick assets refer to the more liquid types of current assets which include: cash and cash equivalents, marketable securities, and short-term receivables. Inventories and prepayments are not included. Hence, the quick ratio can also be computed as:
Quick ratio = (Cash and cash equivalents + Marketable securities + Short-term receivables) ÷ Current liabilities, or
Quick ratio = (Current assets – Inventories – Prepayments) ÷ Current liabilities
The following figures have been taken from the balance sheet of GHI Company.
| Current assets: | ||
| Cash and cash equivalents | $ 76,000 | |
| Marketable securities | 110,000 | |
| Trade and other receivables | 230,000 | |
| Inventories | 167,000 | |
| Prepayments | 42,000 | |
| Total current assets | $ 625,000 | |
| Non-current assets: | ||
| Long-term investments | $ 450,000 | |
| Fixed assets | 900,000 | |
| Total current assets | $ 1,350,000 | |
| TOTAL ASSETS | $ 1,975,000 | |
| Current liabilities | $ 350,000 |
| Non-current liabilities | 900,000 |
| Stockholders' equity | 725,000 |
| TOTAL LIABILITIES & EQUITY | $ 1,975,000 |
| Computation of quick ratio: | ||
| Quick ratio | = | Quick assets ÷ Current liabilities |
| = | ($76,000 + $110,000 + $230,000) ÷ $350,000 | |
| Quick ratio | = | 1.19 |
A quick ratio that is greater than 1 means that the company has enough quick assets to pay for its current liabilities. Quick assets (cash and cash equivalents, marketable securities, and short-term receivables) are current assets that can be converted very easily into cash. Hence, companies with good quick ratios are favored by creditors.
In the example above, the quick ratio of 1.19 shows that GHI Company has enough current assets to cover its current liabilities. For every $1 of current liability, the company has $1.19 of quick assets to pay for it.
The ideal ratio depends greatly upon the industry that the company is in. A company operating in an industry with a short operating cycle generally does not need a high quick ratio. Financial ratios should be compared with industry standards to determine whether such ratios are normal or deviate materially from what is expected.
Quick ratio (acid-test ratio)
