Also known as the acid test, the quick ratio is a measure of liquidity, which is the ability of a company to pay its short term debt obligations using a subset of current assets known as quick assets. The calculation of the quick ratio requires information found on a company’s balance sheet.
Quick Ratio = Quick Assets / Current Liabilities
- Quick Assets = Current Assets – Inventories – Prepaid Expenses
Since prepaid expenses and inventories are more difficult to convert into cash than other current assets (cash, marketable securities, accounts receivable), a ratio known as the Quick Ratio, is sometimes used by analysts and investors to supplement the current ratio. A quick ratio of 1.0 or better is considered satisfactory. When the ratio is greater than 1.0, a company can easily satisfy current liabilities using their quick assets.
When drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry.
Company A’s balance sheet indicates current assets of $12,240,000, inventories of $3,416,000 and prepaid expenses of $1,277,000. Total current liabilities were found to be $5,441,000.
Using the above formula, the quick ratio would be:
= ($12,240,000 – $3,416,000 – $1,277,000) / $5,441,000 = $7,502,000 / $5,441,000, or 1.38
In this example, Company A’s quick ratio is well above 1.0, which is considered satisfactory.