What Is Calculate Quick Ratio?
The 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. The quick ratio formula finance determines how fast a company can repay its current liabilities.
It determines how a company can repay its current liabilities without having to source more finance or sell inventory. A higher ratio would depict higher liquidity for the company. Meaning, they can repay their immediate liabilities without too much hassle. It is considered to be a more conservative approach in comparison to the current ratio.
Table of contents
- The quick ratio formula is a vital liquidity ratio that assesses a company’s ability to meet short-term debts. It is calculated by dividing the sum of cash, cash equivalents, marketable securities, and accounts receivables by current liabilities.
- The quick ratio provides a more accurate evaluation of short-term liquidity compared to the current ratio. It helps management ensure sufficient quick assets are available to settle short-term liabilities on the balance sheet.
- A well-managed short-term financial position is reflected in this ratio, instilling confidence in investors and creditors.
Quick ratio formula is used to determine how a company is equipped to meet their immediate payments or current liabilities without having to sell more from their inventory or secure additional financing.
The Quick Ratio is a more stringent measure of short-term liquidity than 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 convert to cash in the short term or 90 days. The important difference between the Current Ratio formula and the Acid Test Ratio formula is that we exclude 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. Such a situation will make liquidating the inventory more trickier and more time-consuming. The inventory could be in the form of Raw materials or W-I-P.
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 sell 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; 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 company’s actual financial position.
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Quick Ratio Formula Video
Let us understand the formula used for quick ratio formula accounting before we dwell deeper into the concept.
Quick Ratio = (Cash + Short Term Marketable Securities + Accounts Receivables) /Current Liabilities
In case the company is not giving a breakup of Quick Assets, then:
Let us understand the quick ratio financing with the help of a few examples. There practical examples will help us understand the concept in depth.
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 is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year. = $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)
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’s quick ratio is pretty high, primarily due to around $106.73 billion in short-term investments! It 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.
- 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 ideal and satisfactory.
The calculator below can be used for quick ratio formula accounting. This calculator would help the reader understand the concept and their personal liquidity better.
|Quick Ratio =||
Using an Excel sheet can be easier in a lot of cases. Therefore, let us understand how to carry out quick ratio formula finance through the template below.
One needs to provide the two inputs of Total Current Assets and Total Current Liabilities.
Calculation of acid test ratio
Acid test ratio = (Cash + Short-term marketable securities + A/c’s Receivable) / Current Liabilities
Let us understand the significance of quick ratio formula accounting through the explanation below.
- Keeping track of the Quick ratio helps the management determine whether they are maintaining optimum levels of Quick assets to take care of its short-term liabilities in their balance sheets.
- It showcases a well-functioning short-term financial cycle of a company.
- It improves the company’s credibility with the investors by gaining and maintaining their trust in the value of their investments.
- Also, the company’s creditors know that their payments will be made on time.
Frequently Asked Questions (FAQs)
The quick ratio formula, also known as the acid-test ratio, is essential for assessing a company’s short-term liquidity and ability to meet immediate financial obligations. It focuses on quick assets, such as cash, cash equivalents, marketable securities, and accounts receivable, to provide a more stringent measure of a company’s ability to pay off current liabilities without relying on inventory sales.
While the quick ratio is valuable, it has limitations. Excluding inventory from quick assets may not accurately represent a company’s liquidity if it relies heavily on inventory sales. Additionally, the formula may not consider the timing of accounts receivable collections, potentially affecting the interpretation of a company’s liquidity position.
The current ratio and quick ratio are both liquidity ratios but differ in the components they consider. The current ratio includes all current assets, including inventory, in the numerator, while the quick ratio only includes quick assets (cash, cash equivalents, marketable securities, and accounts receivable). The current ratio provides a broader view of a company’s short-term liquidity, while the quick ratio offers a more conservative measure that excludes inventory.
This article has been a guide to what is Quick Ratio Formula. Here we explain its examples, and provided a downloadable Excel template, and a calculator. You may also have a look at these articles below to learn more about Financial Analysis –