What is the quick ratio?

Definition and Examples of Quick Ratio

Types of Financial Ratios

Quick Ratio vs. Current Ratio

What Does That Mean for Individual Investors?

How to Find a Company’s Quick Ratio

Definition and Examples of Quick Ratio

The quick ratio is a simple way to assess whether a company can quickly cover its short-term liabilities. This is important for businesses because creditors, suppliers, and trade partners expect to be paid on time.

Investors will use the quick ratio to determine if the company is in a position to pay its immediate bills. Due to its focus on assets readily available to meet short-term obligations, the quick ratio is also known as the acid-test ratio.

The formula for calculating the quick ratio is quick assets / current liabilities. Quick assets are a portion of current assets that can be easily converted into cash with minimal loss in value. Examples of quick assets include cash, marketable securities, and accounts receivable.

Quick assets can also be thought of as current assets excluding inventory. This is because inventory can sometimes be difficult to convert quickly enough, or it has uncertain liquidity value, so it is not clear whether it can be converted in time or how much cash it would provide. For this reason, the quick ratio formula is often written as follows: (current assets – inventory) / current liabilities.

Current liabilities are the financial obligations that a company must pay within one year.

For example, let’s assume the company has the following current assets:

Cash: $50,000

Marketable securities: $50,000

Accounts receivable: $400,000

Inventory: $450,000

Now, let’s assume that the current liabilities are $350,000.

The company’s quick ratio is: (50,000 + 50,000 + 400,000) / 350,000 = 500,000 / 350,000 = 1.43

This means that the company has $1.43 of quick assets for every dollar of current liabilities. Therefore, the company has sufficient liquidity to pay its short-term bills. Any time the quick ratio is above 1, quick assets exceed current liabilities.

For example, from the illustration above, let’s assume that the company’s current liabilities are instead $600,000. The quick ratio would be: 500,000 / 600,000 = 0.83

Types of Financial Ratios

The quick ratio is just one ratio used to analyze a company’s performance or financial position. There are more financial ratios, which can be classified into types based on their function. The main categories of financial ratios include:

Profitability: These ratios measure a company’s ability to generate returns. Examples include profit margin, return on assets, and return on equity.

Asset Utilization: These ratios measure how effectively a company sells inventory, collects accounts receivable, and uses fixed assets.

Liquidity: These ratios, including quick and current ratios, measure a company’s ability to pay its short-term financial obligations.

Debt Utilization: This ratio assesses a company’s leverage position relative to its assets and earnings.

Quick Ratio vs. Current Ratio

The quick ratio and the current ratio are very similar. They are both liquidity ratios that assess a company’s ability to meet any financial obligations that will come due within one year.

However, the quick ratio is financially more conservative than the current ratio because it only includes the most liquid assets in the account. The quick ratio measures a company’s near-term liquidity relative to its total current assets, including inventory.

For example, using the same information from the previous example, we can calculate the company’s current ratio simply by including inventory: (50,000 + 50,000 + 400,000 + 450,000) / 350,000 = 2.7

What Does That Mean for Individual Investors?

What It Means for Individual Investors

Because the quick ratio is a measure of a company’s ability to meet its financial obligations, it can be an important gauge of the company’s financial status. A company that cannot pay its short-term bills may not remain in business.

Individual investors who choose their own stocks instead of buying index funds or actively managed mutual funds might want to consider the quick ratio as part of their analysis.

How to Find a Company’s Quick Ratio

To calculate a company’s quick ratio, you can look at the company’s most recent financial statement to find the quick assets and current liabilities, as the purpose of the financial statement is to list all of the company’s assets and liabilities. You can then pull the appropriate values from the financial statement and plug them into the formula.

Companies often publish their quarterly and annual financial reports, including their financial statements, on their websites. You can also look for annual and quarterly reports on the Securities and Exchange Commission’s website.

Source: https://www.thebalancemoney.com/what-is-the-quick-ratio-5190637