What is quick ratio? How can you calculate it?

Quick ratio formula

You can quickly calculate the quick ratio of a company with the following formula:

Quick ratio = (Current Assets – Inventories + Cash) / Current Liabilities

The quick ratio of a company indicates to what extent the company is liquid. An organization with a high quick score can therefore easily meet its debt obligations in the short term. Stocks are deducted from current assets. Stocks are often difficult to sell quickly. As a result, they are not suitable for paying off debts in the short term. Stocks can go bad, are fashion sensitive or difficult to sell quickly at a reasonable price.

The quick ratio gives you a better picture of the available liquidity of the organization.

Definition of quick ratio

The quick ratio is a financial index that reflects the financial health of a company in the short term. The ratio disregards the stock.

The quick ratio is mainly used for companies where the stock is not easy to sell. The current ratio is often used for companies where the stock is valuable and stable in value. The financial health of these organizations depends on the stock.

The purpose of quick ratio calculation is to determine whether a company is able to meet all current obligations in the short term.

There are also other names for the quick ratio; the  acid test ratio or quick asset ratio are synonyms of the quick ratio.

Interpretation of quick ratio & explanation

A quick ratio above 1 is generally considered safe. This means that the short-term debts can be paid with the liquid assets. No recourse is made to inventory, other assets or future income. An organization can improve its quick ratio by reducing the number of short-term debt, for example by converting it into long-term debt. Another option is to increase current assets and cash. This can be done by not distributing the profit, raising extra money from shareholders or investing less in fixed assets.

The quick ratio clearly focuses on the short term, which is why only the current (liquid) assets and short-term liabilities are included in the calculation. Companies, creditors and investors alike use the quick ratio calculation. It indicates how likely it is that an organization will run into financial difficulties. The ratio can help estimate the likelihood that a company will be in arrears, resulting in additional costs. You should think of collection costs and possibly even a bailiff who seizes the assets.

Other ratios

In addition to the quick ratio, there are also other important financial key figures. For the health of a company in the short term, you can also look at the  current ratio  and working capital, for example. Other important indicators are solvency, liquidity ,  profitability ,   EBITDA and EBIT .

 

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