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.
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 Ratio. Quick Assets 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 Assets in 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 liabilities 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 Securities = $60,000
- Account Receivables = $40,000
- Inventories = $80,000
Total Current Assets = $410,000
- Account Payable = $260,000,
- Accrual Expenses = $30,000,
- Short-term Debt = $90,000,
- Interest Payable = $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 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 Ratio 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 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 –