Formula to Calculate Quick Ratio
Quick Ratio Formula is one of the most important Liquidity Ratios for determining the company’s ability to pay off its current liabilities in the short term and is calculated as the ratio of cash and cash equivalents, marketable securities, and accounts receivables to Current Liabilities.
Quick Ratio = (Cash + Short Term Marketable Securities + Accounts Receivables) /Current Liabilities
In case the company is not giving a breakup of Quick Assets, then:
The Quick Ratio is a more stringent measure of short-term liquidity as compared to the Current RatioCurrent RatioThe current ratio is a liquidity ratio that measures how efficiently a company can repay it' short-term loans within a year. Current ratio = current assets/current liabilities . Quick AssetsQuick AssetsQuick Assets are assets that are liquid in nature and can be converted into cash easily by liquidating them in the market. Fixed deposits, liquid funds, marketable securities, bank balances, and so on are examples. are the ones that can be converted to cash in the short term or in a period of 90 days. The important difference between the Current Ratio formula and Acid Test Ratio formula is that we are excluding Inventory & Prepaid Expenses as a part of Current AssetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc. in the Quick Ratio formula.
Inventory is excluded because it is assumed that the stock held by the company may not be realized immediately. The inventory could be in the form of Raw materials or W-I-P. Such a situation will make the process of liquidating the inventory all the more tricky and time-consuming.
The ratio of 1 or more indicates that the company can pay off its current liabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They're usually salaries payable, expense payable, short term loans etc. with the help of Quick Assets, and without needing to the sale of its long-term assets and has sound financial health. Care must be exercised in placing too much reliance on acid test ratio without further investigating; For e.g., Seasonal businesses, which seek to stabilize production, might have a weak Quick ratio during its period of slack sales, but a higher one in case of its peak business season. Such situations may prove tricky to know the actual financial position of the company.
Calculation of Quick Ratio Example
You can consider the following example for better understanding:
Masters Co. Ltd has the following details:
- Cash = $200,000
- Advance = $30,000
- Marketable SecuritiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company's balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it. = $60,000
- Account ReceivablesAccount ReceivablesAccounts receivables refer to the amount due on the customers for the credit sales of the products or services made by the company to them. It appears as a current asset in the corporate balance sheet. = $40,000
- Inventories = $80,000
Total Current Assets = $410,000
- Account PayableAccount PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period. = $260,000,
- Accrual Expenses = $30,000,
- Short-term Debt = $90,000,
- Interest PayableInterest PayableInterest Payable is the amount of expense that has been incurred but not yet paid. It is a liability that appears on the company's balance sheet. = $60,000.
Total Current Liabilities = $440,000.
Previous years quick ratio was 1.4 and the industry average is 1.7
Calculation of acid test ratioAcid Test RatioAcid test ratio is a measure of short term liquidity of the firm and is calculated by dividing the summation of the most liquid assets like cash, cash equivalents, marketable securities or short-term investments, and current accounts receivables by the total current liabilities. The ratio is also known as a Quick Ratio. formula:
Quick ratio formula = (Cash + Short-term marketable securities + A/c’s Receivable) / Current Liabilities
= ($200,000 + $60,000 + $40,000) / ($440,000)
= ($300,000) / ($440,000)
- Keeping track of Quick ratio helps the management to determine whether they are maintaining optimum levels of Quick assets so as to take care of its short term liabilities in their balance sheets.
- This showcases a well-functioning short-term financial cycle of a company.
- This improves the credibility of the company with the investors by gaining and maintaining their trust in the value of their investments.
- Also, the creditors of the company know that their payments will be made on time.
As noted from the below graph, the Cash RatioCash RatioCash Ratio is calculated by dividing the total cash and the cash equivalents of the company by total current liabilities. It indicates how quickly a business can pay off its short term liabilities using the non-current assets. of Microsoft is a low 0.110x; however, its quick ratio is a massive 2.216x.
Microsoft quick ratio is pretty high, primarily due to short-term investments of around $106.73 billion! This puts Microsoft in a very comfortable position from the point of view of liquidity / Solvency.
source: Microsoft SEC Filings
- As per the previous year, the company had an acid test ratio of 1.4, whereas this time, it amounts to 0.68.
- From this, we can figure out that the company has not maintained enough Quick assets to pay off its current liabilities. It shows that the company will face potential liquidity problems.
- It might have to sell off its long-term assets to pay off its liabilities if needed, which is not a sign of a healthy and well-managed balance sheet.
- The company should maintain the acid test ratio to at least 1, which is considered ideal and satisfactory.
Quick Ratio Calculator
You can use the following Quick Ratio Calculator
|Quick Ratio =||
Calculate Quick Ratio in Excel (with excel template)
Let us now do the same Quick Ratio example above in Excel.
This is very simple. You need to provide the two inputs of Total Current Assets and Total Current Liabilities.
You can easily calculate the ratio in the template provided.
Calculation of acid test ratio
Acid test ratio = (Cash + Short-term marketable securities + A/c’s Receivable) / Current Liabilities
Quick Ratio Formula Video
This article has been a guide to Quick Ratio Formula. Here we learn how to calculate Quick Ratio with some practical Example, calculator a You may also have a look at these articles below to learn more about Financial Analysis –