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Quick ratio definition

Quick ratio indicates companies’ ability to cover its’ short-term liabilities. Data, needed to calculate this ratio, can be easily obtained from the balance sheet. Quick ratio, unlike the current ratio, evaluates the asset more strictly, excluding the inventory from current assets. It is done because in reality it is very difficult to turn inventory into cash in the short period of time, without experiencing losses. Quick ratio is commonly used to indicate potential liquidity of the company, which is a possible lack of cash. This ratio is also known as acid-test ratio.

It is highly recommended to calculate quick ratio in cases when the company you’re investing your money in, or sell your products for, is sometimes late to cover its’ liabilities. This ratio is quite similar to the current and cash ratios. If you are interested in evaluating company‘s liquidity it is recommended to calculate all those ratios.

Norms and limitations

It is considered that when a value of the ratio is less than 1, such company should be regarded with extreme caution.

It is worth mentioning that quick ratio is even more dependable on the company’s industry than current ratio. If your company’s’ quick ratio differs significantly from a quick ratio of the other companies in the same field of industry, then it is highly recommended to check the quality of your inventory. So the quick (or acid-test) is rather stringent measure. Higher value may indicate that the company has high reserves of cash.

Formula

Current liabilities, also known as short-term debts, indicate debts that must be covered in a period of 12 months.

Current asset is a value that represents such company’s assets’ inventories, receivable accounts, cash and other assets that are reasonably expected to be converted into cash within the period of 12 months.

Inventory represents the raw materials, work-in-process goods and completely finished goods, as this is a background of all processes in business.