Quick ratio

For other uses, see Acid test (disambiguation).

In finance, the Acid-test or quick ratio or liquidity ratio measures the ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately. Quick assets include those current assets that presumably can be quickly converted to cash at close to their book values. A company with a quick ratio of less than 1 cannot currently fully pay back its current liabilities.

Formula

\mbox{Quick (Acid Test) Ratio} = {\mbox{Cash and Cash Equivalent} + \mbox{Marketable Securities} + \mbox{Accounts Receivable}\over \mbox{Current Liabilities}}

Note that inventory is excluded from the sum of assets in the quick ratio, but included in the current ratio. Ratios are tests of viability for business entities but do not give a complete picture of the business' health. If a business has large amounts in accounts receivable which are due for payment after a long period (say 120 days), and essential business expenses and accounts payable due for immediate payment, the quick ratio may look healthy when the business is actually about to run out of cash. In contrast, if the business has negotiated fast payment or cash from customers, and long terms from suppliers, it may have a very low quick ratio and yet be very healthy.

Generally, the acid test ratio should be 1:1 or higher, however this varies widely by industry.[1] In general, the higher the ratio, the greater the company's liquidity (i.e., the better able to meet current obligations using liquid assets).[2]

Acid test ratio

Notice that very often "acid test" refers to cash ratio, instead of quick ratio:

\mbox{Acid Test Ratio} = {\mbox{(Current Assets} - \mbox{Inventory})\over \mbox{Current Liabilities}}[3]

Liquidity ratio

\mbox{Liquidity Ratio} = {\mbox{Cash and Cash Equivalent}\over \mbox{Current Liabilities}}

See also

References

  1. ↑ Tracy, John A. (2004). How to Read a Financial Report: Wringing Vital Signs Out of the Numbers. John Wiley and Sons. p. 173. ISBN 0-471-64693-8.
  2. ↑ Gallagher, Timothy (2003). Financial Management. Englewood Cliffs: Prentice Hall. pp. 94–95. ISBN 0-13-067488-5.
  3. ↑ http://www.investopedia.com/terms/c/cash-ratio.asp
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