Quick Ratio

Financial Dictionary -> Investing -> Quick Ratio

Quick Ratio falls under several names, including the Acid Test and Liquid Ratio. This financial ratio is used to measure a businesses' reliance on external finance and whether it has enough working capital to cover its day to day operations. It is a way of determining if there is enough available cash in the company and in liquid assets to offset its current liabilities. It can be calculated by:

Quick Ratio = (current assets - stock, salaries and supplies) / (current liabilities - bank overdraft)

This is more accurate that the Current Ratio, in that stock is not counted as an asset. There is no guarantee that stock can be sold and if a company is in financial trouble that may be their main problem, so it would be foolish to count stock.

A business should aim for a quick ration of 1:1 or better.

Here is an example of Quick Ratio using a made up balance sheet:
Fixed Assets: $57,000

Current Assets -
Stock: $21,000
Debtors: $25,000
Bank: $2,000
Total Current Assets: $48,000

Current Liabilities -
Crediotrs: $19,000
Overdraft: $0
Total Current Assets: $19,000

Working Capital: $29,000
Total Assets: $86,000

Financed by -
Loans: $40,000
Shares: $46,000
Total Capital Employed: $86,000

This business has trade credit of $19,000, a long term Loan of $40,000 and the owners have invested $46,000, meaning the business has a good working capital situation.

Quick Ratio:
(Current assets - stock) / Current liabilities
= $27,000 / $19,000
= 1.4:1

The quick ratio indicates that the company is well financed and is not relying too heavily on external funding. Its working capital position is very healthy.

This ratio would be of interest to the business itself, so they can look at better financing options for the future and for investors looking at how stable the company is and how close they may be to falling in to debt.