Quick ratio

Definition

The quick ratio, also known as the acid-test ratio, is a financial metric that measures a company's ability to meet its short-term obligations using its most liquid assets. It focuses on the company's cash, cash equivalents, and accounts receivable, excluding inventory from current assets, to provide a more stringent assessment of liquidity. This ratio is particularly important in financial statement analysis as it gives insight into a company's operational efficiency and financial health.

5 Must Know Facts For Your Next Test

1. The quick ratio is calculated using the formula: Quick Ratio = (Cash + Cash Equivalents + Accounts Receivable) / Current Liabilities.
2. A quick ratio of 1 or above is generally considered satisfactory, indicating that the company has enough liquid assets to cover its short-term liabilities.
3. Unlike the current ratio, the quick ratio excludes inventory, which may not be as easily converted to cash in the short term.
4. This metric is particularly useful for industries where inventory turnover is slow or where inventory is not readily convertible to cash.
5. Investors and creditors often look at the quick ratio as a more conservative measure of liquidity compared to other ratios.

Review Questions

• How does the quick ratio differ from the current ratio in assessing a company's liquidity?
  • The quick ratio differs from the current ratio primarily in what assets are included in the calculation. While the current ratio considers all current assets, including inventory, the quick ratio only takes into account liquid assets such as cash, cash equivalents, and accounts receivable. This makes the quick ratio a more stringent measure of liquidity, as it provides a clearer picture of a company's ability to meet its short-term obligations without relying on inventory sales.
• Evaluate why the quick ratio might be especially significant for companies in specific industries like retail or manufacturing.
  • The quick ratio is particularly significant for retail and manufacturing companies due to their reliance on inventory. In these sectors, inventory can take time to sell and may not be easily converted into cash during financial distress. A low quick ratio could indicate potential liquidity issues for these companies if they are unable to quickly convert their receivables into cash. Thus, understanding this metric helps investors assess risk in industries where slow-moving inventory could impact financial stability.
• Analyze how changes in accounts receivable might affect a company's quick ratio and what implications this could have for stakeholders.
  • Changes in accounts receivable directly influence a company's quick ratio since this component is part of the numerator in the formula. If accounts receivable increase significantly without a corresponding increase in cash or cash equivalents, it could inflate the quick ratio, potentially masking liquidity issues if those receivables are not collected promptly. For stakeholders like investors and creditors, an overstated quick ratio may lead them to misjudge the company's actual financial health and ability to meet short-term obligations, increasing their risk exposure.

Related terms

current ratio: A liquidity ratio that measures a company's ability to pay short-term liabilities with short-term assets, including inventory.

liquidity: The availability of liquid assets to a company, reflecting how easily it can meet its financial obligations without needing to sell long-term investments.

working capital: The difference between a company's current assets and current liabilities, indicating the short-term financial health and operational efficiency.