Like other liquidity ratios, a ratio of 1 or above means the ratio indicates the company can meet its current liquidity needs. While the quick ratio is a quick & easy method of determining the company’s liquidity position, diligence must be done in interpreting the numbers. To get the complete picture, it is always better to break down the analysis and see the reason for the high quick ratio. The company appears not to have enough liquid current assets to pay its upcoming liabilities. The quick ratio is thus considered to be more conservative than the current ratio, since its calculation intentionally ignores more illiquid items like inventory.
- Like other liquidity ratios, a ratio of 1 or above means the ratio indicates the company can meet its current liquidity needs.
- Suppose a company has the following balance sheet financial data in Year 1, which we’ll use as our assumptions for our model.
- If the ratio is low, the company should likely proceed with some degree of caution, and the next step would be to determine how and how quickly more capital could be obtained.
- The ratio is important because it signals to internal management and external investors whether the company will run out of cash.
- An “acid test” is a slang term for a quick test designed to produce instant results.
Upon dividing the sum of the cash and cash equivalents, marketable securities, and accounts receivable balance by the total current liabilities balance, we arrive at the quick ratio for each period. Enter a company’s cash and cash equivalents, accounts receivable, and other marketable securities, then enter current liabilities to compute the quick ratio. The quick ratio measures if a company, post-liquidation of its liquid current assets, would have enough cash to pay off its immediate liabilities — so, the higher the ratio, the better off the company is from a liquidity standpoint.
Understanding the Quick Ratio
The Quick Ratio Calculator will calculate the quick ratio of any company if you enter in the current assets, current inventory, and the current liabilities of the company. The quick ratio is a liquidity ratio that is also known as the acid test ratio and is often used to measure the short term liquidity of a company (and it’s ability to meet its short term debt obligations using current assets besides its inventory). With a quick ratio of over 1.0, Johnson & Johnson appears to be in a decent position to cover its current liabilities as its liquid assets are greater than the total of its short-term debt obligations. Procter & Gamble, on the other hand, may not be able to pay off its current obligations using only quick assets as its quick ratio is well below 1, at 0.45.
It also makes sense to look at the contribution weightage of each asset in the overall quick assets. The Quick Ratio measures the short-term liquidity of a company by comparing the value of its cash balance and liquidated current assets to its near-term obligations. The quick ratio has the advantage of being a more conservative estimate of how liquid a company is. Compared to other calculations that include potentially illiquid assets, the quick ratio is often a better true indicator of short-term cash capabilities.
What Is the Quick Ratio?
A company should strive to reconcile their cash balance to monthly bank statements received from their financial institutions. This cash component may include cash from foreign countries translated to a single denomination. The higher the quick ratio, the better a company’s liquidity and financial health, but it important to look at other related measures to assess the whole picture of a company’s financial health. Let’s be honest – sometimes the best quick ratio calculator is the one that is easy to use and doesn’t require us to even know what the quick ratio formula is in the first place! But if you want to know the exact formula for calculating quick ratio then please check out the “Formula” box above. Otherwise referred to as the “acid test” ratio, the quick ratio’s distinction from the current ratio is that a more stringent criterion is applied for the current assets included in the calculation.
Regardless of which method is used to calculate quick assets, the calculation for current liabilities is the same as all current liabilities are included in the formula. Since it indicates the company’s ability to instantly use its near-cash assets (assets that can be converted quickly to cash) to pay down its current liabilities, it is also called the acid test ratio. An “acid test” is a slang term for a quick test designed to produce instant results.
Quick Ratio Formula With Examples, Pros and Cons
A company that has a quick ratio of less than 1 may not be able to fully pay off its current liabilities in the short term, while a company having a quick ratio higher than 1 can instantly get rid of its current liabilities. For instance, a quick ratio of 1.5 indicates that a company has $1.50 of liquid assets available to cover each $1 of its current liabilities. From the above calculation, it is clear that the short-term liquidity position of Reliance Industries is not good. Reliance Industries has 0.44 INR in quick assets for every 1 INR of current liabilities. The total accounts receivable balance should be reduced by the estimated amount of uncollectible receivables. As the quick ratio only wants to reflect the cash that could be on hand, the formula should not include any receivables a company does not expect to receive.
Cash equivalents are often an extension of cash as this account often houses investments with very low risk and high liquidity. Cash equivalents often include but may not necessarily be limited to Treasury bills, certificates of deposits (being mindful of options/fees to break the CD), bankers’ acceptances, corporate commercial paper, or other money market instruments. The significant figures drop select box only determines rounding for the ratios themselves. In fact, such a company may be viewed favorably by the equity or debt capital markets and be able to raise capital easily. For example, a company with a low ratio might not be at too much of a risk if it has non-core fixed assets on standby that could be sold relatively quickly.
What is a Good Quick Ratio?
If the ratio is low, the company should likely proceed with some degree of caution, and the next step would be to determine how and how quickly more capital could be obtained. The two general rules of thumb for interpreting the quick ratio are as follows. We also provide you with a Quick Ratio calculator and a downloadable Excel template.
The quick ratio is equivalent to the acid test ratio in GAAP accounting, which approaches the same number by netting certain assets from current assets. In certain situations in other accounting regimes, the two may differ; consider a company with hard or impossible to liquidate current assets like prepaid taxes or insurance contracts listed as current assets. In Year 1, the quick ratio can be calculated by dividing the sum of the liquid assets ($20m Cash + $15m Marketable Securities + $25m A/R) by the current liabilities ($150m Total Current Liabilities). Similar to the current ratio, which also compares current assets to current liabilities, the quick ratio is categorized as a liquidity ratio. On the other hand, a company could negotiate rapid receipt of payments from its customers and secure longer terms of payment from its suppliers, which would keep liabilities on the books longer. By converting accounts receivable to cash faster, it may have a healthier quick ratio and be fully equipped to pay off its current liabilities.