Quick Ratio

by Investing School on April 28, 2010

A quick ratio is a ratio that will give you information about a company’s short term liquidity. The quick ratio will be able to tell you if the company is able to meet its short-term obligations with the most liquid assets it has at its disposal. The higher the ratio is for a company, the better the financial health of that particular company. Quick ratio is sometimes referred to as the acid-test or the liquid ratio.

The quick ratio is a more conservative formula than the current ratio. Current ratio is a much used and well-know liquidity measure but quick ratio excludes inventory from current assets as part of its calculation. This is done because there are some companies that may have difficulty turning their inventory into cash. If there is a situation where cash is needed quickly, the current ratio may overstate what the company’s current financial state is. The quick ratio will give you a much more conservative few and if your company has a high number then you can rest easy knowing that all short-term obligations can be met with ease.

The formula requires that you subtract inventories from the company’s current assets and then divide it by the business’s current liabilities. For example, if current assets are $15,000,000, current inventory is $6,000,000 then the quick ratio is 3. From this formula you are able to see that for each dollar that is needed for current liabilities there are $3 of assets that can be easily converted into cash.

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