What Is Quick Ratio?
The Quick Ratio is also commonly referred to as the Acid-Test Ratio. It assesses a company’s capacity to settle its short-term obligations (i.e., liabilities) using liquid assets (not including inventory). It measures the company's overall financial health by determining whether it can meet its current obligations without selling inventory.
Who Uses Quick Ratio?
- Investors & Analysts: Assessment of liquidity and financial stability of the company.
- Creditors and Lenders: Evaluate the organisation’s capacity to repay its current liabilities to its creditors before advancing a loan or extending credit to the organisation.
- Company management: Understand cash flow quickly for an assessment of liquidity.
Quick Ratio Formula
Quick Ratio = (Current Assets - Inventories) / Current Liabilities.
Advantages Of Quick Ratio
- More Accurate Measure of Liquidity: It is a better measure than the current ratio, as inventory may or may not as easily be converted to cash.
- Helps with Financial Decision Making: Understanding whether a company has enough liquid assets to cover short-term obligations is important to know.
- Useful for Creditors & Investors: Understanding a company’s financial risk before lending or investing is key.
- Avoids overestimating immediate financial strength in inventory: Quick ratios help to ensure businesses do not overestimate their short-term financial circumstances.
Key Takeaways
The Quick Ratio (acid-test ratio) assesses an organisation’s ability to meet its short-term obligations with its most liquid assets, excluding inventory. Investors, creditors, and management are some who use the ratio to analyse solvency and liquidity. The quick ratio gives a more accurate measure of liquidity than the current ratio, assists in financial planning, is helpful for creditors and investors, and helps avoid over-reliance on inventory.
