what-is-quick-ratio

What is the quick ratio?

The Acid-test or quick ratio or liquid ratio measures the ability of a company to meet its financial obligations in the short-term. Indeed, the metric is given by current assets minus inventories, over current liabilities; In short, it shows the ratio between assets easily convertible in cash and short-term obligations. The higher the better. 

The Quick Ratio is going to tell us a lot about the business. On the other hand, when analyzing a manufacturing company the efficiency ratios may tell us much more about the business. Indeed, in such scenario, the way inventories, receivable and payable are managed is crucial to give enough oxygen to the business itself. Therefore, in conjunction with the quick ratio, the inventory turnover, accounts receivable and accounts payable turnover will give us a clearer account of the business.

Case Study:

Imagine that of $100K of current assets. Of which $80K are liquid assets, the remaining portion is inventory. The liability stays at $75k. The quick ratio will be 1.06 times or $80K/$75K. Therefore, the liabilities can be met in the very short-term through the company’s liquid assets. To assess if there was an improvement in the creditworthiness of the business we have to compare this data with the previous year. Although a quick ratio of over 1, can generally be accepted, while below one is seen as undesirable since you will not be able to pay very short-term obligations unless part of the inventories is sold and converted into cash.

If you lack a foundation of financial accounting and want to start from scratch, you can consult my book:

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Gennaro Cuofano

Creator of FourWeekMBA.com | Head of Business Development at WordLift.io | International MBA

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