Presentation of the Quick Ratio

The quick ratio measures a company's ability to pay its current liabilities without having to sell its inventory or obtain additional financing. The quick ratio is considered a more conservative measure than the current ratio, which includes all current assets to cover current liabilities.

A result of 1 is considered the normal quick ratio. It indicates that the company has exactly enough assets to be liquidated immediately to pay off its current liabilities. A company with a quick ratio less than 1 may not be able to pay off its current liabilities in full in the short term, while a company with a quick ratio greater than 1 can pay off its current liabilities immediately. For example, a quick ratio of 1.5 indicates that a company has $1.50 in liquid assets to cover each $1 of current liabilities.

Formula of the Quick Ratio

$\text{Quick Ratio}=\frac{\text{Quick Assets}}{\text{Current Liabilities}}$

Where :

$\text{Quick Assets}=\text{Cash}+\text{MS}+\text{NAR}$

$\text{MS}=\text{Marketable Securities}$

$\text{NAR}=\text{Net Accounts Receivable }$

Or :

$\text{Quick Assets}=\text{TCA}+\text{Inventory}+\text{PE}$

$\text{TCA}=\text{Total Current Assets}$

$\text{PE}=\text{Prepaid Expenses}$

Interpretation of the Quick Ratio

The quick ratio has the advantage of being a more conservative estimate of a company's liquidity. Compared to other calculations that include potentially illiquid assets, the quick ratio is often a better true indicator of short-term liquidity.

The quick ratio is also relatively simple and straightforward to calculate. It's relatively easy to understand, especially when comparing a company's liquidity to a target calculation such as 1.0. The quick ratio can be used to analyze a single company over a period of time or to compare similar companies.

There are several drawbacks to the quick ratio. The financial ratio does not provide any indication of a company's future cash flow activity. Although a company may be sitting on $1 million today, it may not be selling a profitable product and may struggle to maintain its cash balance in the future. There are also considerations to be made regarding the true liquidity of accounts receivable as well as marketable securities in some situations.