Definition of Quick Ratio
The quick ratio measures a company’s liquidity position at a specific point in time. It reflects the company’s ability to meet its short term liabilities without relying on inventory or external financial support. This is achieved through assets that can be quickly converted into cash, known as quick assets.
Because it evaluates a company’s ability to settle liabilities using these liquid assets, the quick ratio is also referred to as the acid test ratio or liquidity ratio.
What is Quick Ratio?
The quick ratio assesses a company’s ability to meet short-term obligations by comparing its liquid assets to its current liabilities. Liquid assets are current assets that can quickly be converted into cash, while liabilities represent debts owed by the company to external parties.
A quick ratio of 1 or higher indicates that the company has sufficient liquid assets to cover its liabilities, while a ratio below 1 suggests the company’s liabilities exceed its liquid assets, signaling potential liquidity challenges.
This metric is a valuable tool for evaluating whether a company can manage its short-term obligations independently, without relying on inventory or external financing. Investors also use the quick ratio as a benchmark to determine a company’s financial stability and decide whether to invest.
What is the formula for quick ratio?
The formula for quick ratio is :
Quick Ratio = CE + MS + AR/CL
Or
Quick Ratio = CA − I − PE/CL
where, CE = Cash and equivalents; MS = Marketable securities; AR = Accounts receivable; CL = Current liabilities; CA = Current assets; I = Inventory; PE = Prepaid expenses
