Do the company’s current assets easily cover its current liabilities?
Over 2 million + professionals use CFI to learn accounting, financial analysis, modeling and more. Unlock the essentials of corporate finance with our free resources and get an exclusive sneak peek at the first module of each course. Start Free
What is the Quick Ratio?
The Quick Ratio, also known as the Acid-test or Liquidity ratio, measures the ability of a business to pay its short-term liabilities by having assets that are readily convertible into cash. These assets are, namely, cash, marketable securities, and accounts receivable. These assets are known as “quick”assets since they can quickly be converted into cash.
The Quick Ratio Formula
Quick Ratio =[Cash & equivalents + marketable securities + accounts receivable] /Current liabilities
Or, alternatively,
Quick Ratio =[Current Assets – Inventory – Prepaid expenses] / Current Liabilities
Example
For example, let’s assume a company has:
- Cash: $10 Million
- Marketable Securities: $20 Million
- Accounts Receivable: $25 Million
- Accounts Payable: $10 Million
This company has a liquidity ratio of 5.5, which means that it can pay its current liabilities 5.5 times over using its most liquid assets. A ratio above 1 indicates that a business has enough cash or cash equivalents to cover its short-term financial obligations and sustain its operations.
The formula in cell C9 is as follows= (C4+C5+C6) / C7
This formula takes cash, plus securities, plus AR, and then divides that total by AP (the only liability in this example).
The result is 5.5.
Download the Free Template
Enter your name and email in the form below and download the free template now!
Quick Ratio Template
Download the free Excel template now to advance your finance knowledge!
What’s Included and Excluded?
Generally speaking, the ratio includes all current assets, except:
- Prepaid expenses – because they can not be used to pay other liabilities
- Inventory – becauseit may take too long to convert inventory to cash to cover pressing liabilities
As you can see, the ratio is clearly designed to assess companies where short-term liquidity is an important factor. Hence, it is commonly referred to as the Acid Test.
The Quick Ratio In Practice
The quick ratio is the barometer of a company’s capability and inability to pay its current obligations. Investors, suppliers, and lenders are more interested to know if a business has more than enough cash to pay its short-term liabilities rather than when it does not. Having a well-defined liquidity ratio is a signal of competence and sound business performance that can lead to sustainable growth.
To learn more about this ratio and other important metrics, check out CFI’s course onperforming financial analysis.
Quick Ratio vs Current Ratio
The quick ratio is different from the current ratio, as inventory and prepaid expense accounts are not considered in quick ratio because, generally speaking, inventories take longer to convert into cash and prepaid expense funds cannot be used to pay current liabilities. For some companies, however, inventories are considered quick assets; it depends entirely on the nature of the business, but such cases are extremely rare.
Additional Resources
Thank you for reading CFI’s guide to Quick Ratio. To keep learning and advancing your career as a financial analyst, these additional CFI resources will help you on your way:
FAQs
A quick ratio above 1.0 indicates a company has enough quick assets to cover its current liabilities. A higher ratio indicates that the company has more liquidity and financial flexibility. Here's a quick ratio guide for determining what is a good ratio: Less than 1: Unhealthy.
What is a good quick ratio result? ›
Generally speaking, a good quick ratio is anything above 1 or 1:1. A ratio of 1:1 would mean the company has the same amount of liquid assets as current liabilities. A higher ratio indicates the company could pay off current liabilities several times over.
Is a quick ratio of 0.2 good? ›
A good liquidity ratio varies by industry and specific circ*mstances, but a current ratio of 2:1 is generally considered solid, indicating a company has twice as many current assets as liabilities. A 1:1 ratio is desirable for the quick ratio, and a cash ratio of at least 0.2:1 is considered sound.
What is quick ratio answer? ›
The quick ratio represents the extent to which a business can pay its short-term obligations with its most liquid assets. In other words, it measures the proportion of a business's current liabilities that it can meet with cash and assets that can be readily converted to cash.
Is a quick ratio of .75 good? ›
What is a good quick ratio? Generally, the higher the quick ratio, the better the financial health of your company. However, if your quick ratio is too high, you may not be properly investing your current assets aggressively. Generally, you want to keep your quick ratio above 1.0.
Is a quick ratio of 2.5 good? ›
What is a good quick ratio for a company? A quick ratio above one is excellent because it shows an even match between your assets and liabilities.
What is the rule of thumb for quick ratio? ›
The quick ratio is used as a test of liquidity because it does not include inventories or prepaid expenses (if any). A rule of thumb for good liquidity is to have a quick ratio of at least 1:1.
Is a quick ratio of 1.0 good? ›
However, a quick ratio of 1.0 is generally considered good, indicating that the company has as much in its most liquid assets as it owes in short-term liabilities. Remember, context matters.
What does a quick ratio of 0.5 mean? ›
So, the quick ratio = (1/2) = 0.5, which means it has enough money to pay half of its current liabilities. If we compare this number with the quick ratios of other companies, we will know how good it is compared to others. Hence, we can say that the higher the value of this ratio, the better it is for a company.
What is a 0.4 quick ratio? ›
The company's current ratio of 0.4 possibly indicates an inadequate degree of liquidity, with only $0.40 of current assets available to cover every $1 of current liabilities. The quick ratio suggests an even less liquid position, with only $0.20 of liquid assets for every $1 of current liabilities.
Limitations of the Quick Ratio
The Quick Ratio does not provide a comprehensive picture of a company's liquidity position. It does not account for elements like working capital, which can offer additional insights into a company's financial health. Therefore, it should not be the only ratio used in financial analysis.
What does a low quick ratio indicate? ›
A quick ratio below 1 shows that a company may not be in a position to meet its current obligations because it has insufficient assets to do so. This tells potential investors that the company in question is not generating enough profits to meet its current liabilities.
Is 0.2 a good quick ratio? ›
If a cash ratio is 0.2, it means that a company likely has more current liabilities than it does cash or cash assets to pay them off. This situation poses a significant problem for finance providers, who are less likely to offer funding to a company burdened with high current liabilities.
What is a healthy quick ratio? ›
With a quick ratio of over 1.0, XYZ appears to be in a decent position to cover its current liabilities, as its liquid assets are greater than the total of its short-term debt obligations.
Is a quick ratio of 0.7 good? ›
Indicates the number dollars of quick assets available to pay each dollar of current liabilities. Generally, a Quick Ratio of 1.0 or greater is considered adequate to ensure a company's ability to pay its current obligations. A value of less than 1.0 signals a problem in meeting short-term obligations.
What does a quick ratio of 1.5 mean? ›
For instance, a quick ratio of 1.5 indicates that a company has $1.50 of liquid assets available to cover each $1 of its current liabilities. While such numbers-based ratios offer insight into the viability and certain aspects of a business, they may not provide a complete picture of the overall health of the business.
Is 0.7 a good quick ratio? ›
At 0.7, the company only has $0.70 of liquid assets available for every $1 of current liabilities. This is considered a warning sign. Reasons for a low quick ratio can include too much debt, problems collecting receivables, or excessive inventory levels. It may indicate deeper issues with profitability or cash flow.
