This article explains the quick ratio in a practical way. After reading you will understand the basics of this powerful financial management tool.
What is the Quick Ratio (QR)?
The quick ratio (also known as the quick assets ratio) is a calculation formula and liquidity indicator that measures to what extent a company can meet its short-term liabilities with liquid assets.
The most important difference with the current ratio is that the quick ratio excludes inventories. The reason for this is the conversion of inventories into cash.
The formula for the calculation is as follows:
|Quick Ratio =||>Liquid Assets + debtors* / Short-Term Liabilities**|
* = Liquid assets are resources that are readily available such as cash and money in bank accounts. Debtors are the customers who still have to settle their invoices.
** = Short Term Liabilities is the capital that has to be repaid within a short time for example a supplier’s credit, creditors or an overdraft facility.
With the exception of the inventories, this ratio focuses more on the liquid assets of an organization. The basis and use of this ratio is comparable with the current ratio i.e. the ability of an organization to meet their short-term obligations with their short-term assets.
It may be useful to compare the QR with the current ratio. If the current ratio is significantly higher, there is a clear indication the current assets of the organization are dependent on the inventories.
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- Parrino, R., Kidwell, D. S., & Bates, T. W. (2009). Fundamentals of corporate finance. John Wiley & Sons.
- Ross, S. A., Westerfield, R., & Jordan, B. D. (2008). Fundamentals of corporate finance. McGraw-Hill Education.
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