Quick ratio

The Quick ratio, also known as the acid-test ratio, is a liquidity ratio that measures an entity's ability to meet its short-term liabilities using assets that can be converted into cash relatively quickly.

A simplified formula is:

$\text{Quick Ratio}=\frac{\text{Cash and Cash Equivalents}+\text{Marketable Securities}+\text{Accounts Receivable}}{\text{Current Liabilities}}$

An equivalent formulation is:

$\text{Quick Ratio}=\frac{\text{Quick Assets}}{\text{Current Liabilities}}$

where quick assets generally comprise assets that are expected to be converted into cash within a relatively short period, while excluding assets such as inventory and prepaid expenses that may not be readily convertible into cash.

Interpretation

The quick ratio indicates the extent to which an entity's readily realizable assets can cover its current liabilities.

A simplified relationship is:

$\text{Quick Ratio}\ge 1\to \text{Quick Assets}\ge \text{Current Liabilities}$

Conversely:

$\text{Quick Ratio}<1\to \text{Quick Assets}<\text{Current Liabilities}$

A quick ratio above 1 does not necessarily mean that an entity has no liquidity risk, while a ratio below 1 does not necessarily indicate financial distress. The appropriate level varies according to the entity's industry, business model, cash-flow characteristics, and access to financing.

Example

Suppose a company has:

• $50 million in cash and cash equivalents;
• $20 million in marketable securities;
• $30 million in accounts receivable;
• $80 million in current liabilities.

Its quick ratio is:

$\text{Quick Ratio}=\frac{50+20+30}{80}=1.25$

The company therefore has $1.25 of quick assets for every $1 of current liabilities.

Quick ratio and current ratio

The quick ratio is generally more restrictive than the Current ratio because it excludes assets that may take longer to convert into cash.

The current ratio is:

$\text{Current Ratio}=\frac{\text{Current Assets}}{\text{Current Liabilities}}$

The quick ratio can therefore be represented conceptually as:

$\text{Quick Assets}\subseteq \text{Current Assets}$

and generally:

$\text{Quick Ratio}\le \text{Current Ratio}$

when the numerator of the quick ratio is a subset of current assets and the same current liabilities are used in both calculations.

Quick assets

The precise definition of quick assets can vary depending on the accounting framework and analytical methodology.

Commonly included items may include:

• cash and cash equivalents;
• short-term marketable securities;
• accounts receivable, subject to applicable adjustments.

Inventory is generally excluded because it may require production, sale, and collection before becoming cash.

Prepaid expenses are generally excluded because they normally cannot be converted back into cash to settle current liabilities.

A simplified relationship is:

$\text{Quick Assets}=\text{Current Assets}-\text{Inventory}-\text{Prepaid Expenses}-\text{Other Non-Quick Current Assets}$

Alternative formulation

When quick assets are defined as current assets less inventory and prepaid expenses, the ratio can be expressed as:

$\text{Quick Ratio}=\frac{\text{Current Assets}-\text{Inventory}-\text{Prepaid Expenses}}{\text{Current Liabilities}}$

The appropriate formulation depends on the accounting presentation and the definition of quick assets being used.

Relationship to liquidity risk

The quick ratio can provide an indication of short-term liquidity but does not fully measure Liquidity risk.

A simplified relationship is:

$\text{Quick Assets}\to \text{Potential Short-Term Liquidity}$

The ratio does not necessarily capture:

• the timing of cash inflows and outflows;
• the collectability of receivables;
• restrictions on cash;
• changes in marketable-security values;
• available credit facilities;
• unexpected cash requirements;
• market liquidity conditions.

Consequently, the quick ratio is generally used together with other liquidity measures and cash-flow analysis.

Limitations

The quick ratio has several limitations.

Accounts receivable may be included in quick assets even though some receivables may be collected slowly or may become uncollectible.

Similarly, marketable securities may experience changes in market value or may not be equally liquid under stressed market conditions.

The ratio is also measured at a particular point in time and therefore does not necessarily represent an entity's liquidity position throughout an accounting period.

A simplified distinction is:

$\text{Quick Ratio}\to \text{Balance-Sheet Liquidity Measure}$

$\text{Cash-Flow Analysis}\to \text{Timing and Sustainability of Cash Availability}$

See also

• Liquidity
• Liquidity risk
• Current ratio
• Cash ratio
• Working capital
• Financial ratio
• Solvency risk
• Liquidity Coverage Ratio