30 Mar 2018

Quick Ratio

Finance feed by:

CA Rahul Agarwal
B.com (Hons),CA
CA in Practice
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   •    13 Year 3 Month  experience

The quick ratio matches the most easily liquidated portions of current assets with current liabilities. It is used to evaluate whether a business has sufficient assets that can be converted into cash to pay its bills. The key elements of current assets that are included in the quick ratio are cash, marketable securities, and accounts receivable. Inventory is not included in the ratio, since it can be quite difficult to sell off in the short term, and possibly at a loss. Because of the exclusion of inventory from the formula, the quick ratio is a better indicator than the current ratio of the ability of a company to pay its immediate obligations.

To calculate the quick ratio, summarize cash, marketable securities and trade receivables, and divide by current liabilities. Do not include in the numerator any excessively old receivables that are not likely to be paid. The formula is:
(Cash + Marketable securities + Accounts receivable) ÷ Current liabilities 

Despite the absence of inventory from the calculation, the quick ratio may still not yield a good view of immediate liquidity, if current liabilities are payable right now, while receipts from receivables are not expected for several more weeks. This can be a particular concern when a business has granted its customers long payment terms.

The ratio is most useful in manufacturing, retail, and distribution environments where inventory can comprise a large part of current assets. It is particularly useful from the perspective of a potential creditor or lender that wants to see if a credit applicant will be able to pay in a timely manner, if at all.

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