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What is Quick Ratio? Example, Definition, Formula

what is quick ratio

Quick ratio is also known as acid test ratio, is a formula used to assess a company’s capacity to make on-time payments by comparing its short-term assets to short-term obligations and determining if it has sufficient cash on hand to cover those immediate commitments. The short-term debt is included in the acid test ratio but not current assets that are difficult to sell, such as inventories. 

How quick can I sell off my assets?

After reading this post you will be cleared through the term “what is quick ratio”?

Assume a company is struggling to do sales, and they have taken a loan from the bank, now the bank is asking to pay back the loan since the period is over and the company doesn’t have money. then they are going to sell their assets and in exchange for it, they will get cash with which they can pay the debt along with interest.  

Will the bank gets its money?

It purely depends on the quick ratio which measures a company’s ability to meet its short-term obligations with the most liquid assets. 

Deep Down : Quick Ratio

We hope you have little idea of what a quick ratio means. The main difference between current ratio and quick ratio is inventories since it is more difficult to turn into cash which makes the quick ratio more conservative than the current ratio. The main thing you have to remember is that the quick ratio does not include inventories. 

Quick Ratio Formula

Making of Quick ratio formula and derivation of the quick ratio formula will help you to learn its formula in an efficient way.

Add up an organization’s cash, marketable securities, and accounts receivable (Current assets excluding inventories), then divide by the sum of its current liabilities to determine its quick ratio. On a company’s balance sheet, each of these elements is listed separately. On the balance statement, a subtotal for current obligations is shown. Mathematically we can express the quick ratio as:

Quick Ratio = (Current Assets – Inventories)/Current Inventories

This ratio is used to assess a company’s liquidity, thus be sure to exclude non-accessible assets out of the calculations for cash, marketable securities, and accounts receivable. For instance, do not include cash or marketable securities in the computation if their usage is prohibited. Similar to that, think about eliminating any accounts receivable from the computation if you are aware of any that are not anticipated to be paid on time. Don’t include inventory in the computation either because it may take a while (or never) to turn it into cash. The ratio won’t produce an accurate understanding of a company’s liquidity until then.

More on Quick Ratio

A better ratio is 2:1, which often denotes adequate cash to pay all commitments. Even with such a favorable ratio, scheduling discrepancies may still occur. For instance, a sizable debt may be due for payment in a few days but the offsetting assets may not be liquidated for a few more weeks.

When the quick ratio is 1:1 or worse, it means that there is a considerable chance that the company won’t be able to cover its debts when they become due. Even a low ratio, however, could not be a reliable sign of payment issues if a company has a line of credit that can be used to pay off any commitments as they become due. This is also true when a wealthy investor is available to provide more funding for the company as needed.

Companies having higher acid test ratios than those with lower quick ratios are seen to be more financially stable. For external stakeholders like creditors, lenders, investors, and capitalists, an acid test ratio greater than 1 is vital and seen as healthy.

The following three strategies will help a company’s quick ratio:

  1. Clear liabilities as soon as possible. 

No one likes liability whether you are a company or an individual. If a company is able to set off its short-term liabilities then this will automatically impact the denominator of the quick ratio formula and it will result in more figures in the quick ratio formula. quick ratio analysis is needed for this. 

2. Collect Outstanding Payments as soon as possible.

This money also performs as a current asset for the company. The acid ratio test for your company will be directly and favorably impacted by cutting the amount of time it takes to collect your accounts receivable.

3.Try to increase the sales. 

Not for improving quick ratio but to grow in future you have to do this. All business are required to do this. 

Final Words

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We hope We gave you some insights about quick ratio meaning, current ratio vs quick ratio, how to calculate quick ratio, what is the ideal quick ratio, and delivered it in the best possible way. 

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Rupay Rajat
Rupay Rajat

Rupay Rajat is a financial and investing blog. I write about financial instruments and the stock market in the most easiest language.