Quick ratio

In finance, the quick ratio, also known as the acid-test ratio [1] is a type of liquidity ratio [2] which measures the ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately. Quick assets include those current assets that presumably can be quickly converted to cash at close to their book values. It is the ratio between quickly available or liquid assets and current liabilities.

A normal liquid ratio is considered to be 1:1. A company with a quick ratio of less than 1 cannot currently fully pay back its current liabilities.

This ratio is considered to be much better and reliable as a tool for assessment of liquidity position of firms.

Formula

or specifically:

Note that inventory is excluded from the sum of assets in the quick ratio, but included in the current ratio. Ratios are tests of viability for business entities but do not give a complete picture of the business' health. If a business has large amounts in accounts receivable which are due for payment after a long period (say 120 days), and essential business expenses and accounts payable due for immediate payment, the quick ratio may look healthy when the business is actually about to run out of cash. In contrast, if the business has negotiated fast payment or cash from customers, and long terms from suppliers, it may have a very low quick ratio and yet be very healthy.

More detailed analysis of all major payables and receivables in line with market sentiments and adjusting input data accordingly shall give more sensible outcomes which shall give actionable insights.

Generally, the acid test ratio should be 1:1 or higher; however, this varies widely by industry.[3] In general, the higher the ratio, the greater the company's liquidity (i.e., the better able to meet current obligations using liquid assets).[4]

See also

References

  1. ↑ AccountingCoach LLC, What is the quick ratio?, accessed 2 July 2018
  2. ↑ AccountingCoach LLC, What is a liquidity ratio?, accessed 2 July 2018
  3. ↑ Tracy, John A. (2004). How to Read a Financial Report: Wringing Vital Signs Out of the Numbers. John Wiley and Sons. p. 173. ISBN 0-471-64693-8.
  4. ↑ Gallagher, Timothy (2003). Financial Management. Englewood Cliffs: Prentice Hall. pp. 94–95. ISBN 0-13-067488-5.
This article is issued from Wikipedia. The text is licensed under Creative Commons - Attribution - Sharealike. Additional terms may apply for the media files.