Formula to Calculate Quick Ratio

Quick Ratio Formula is one of the most important Liquidity Ratios for determining the company’s ability to pay off its current liabilities in the short term and is calculated as the ratio of cash and cash equivalents, marketable securities, and accounts receivables to Current Liabilities.

Quick Ratio = (Cash + Short Term Marketable Securities + Accounts Receivables) /Current Liabilities

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OR

In case the company is not giving a breakup of Quick Assets, then:

Explanation

The Quick Ratio is a more stringent measure of short-term liquidity than the Current RatioCurrent RatioThe current ratio is a liquidity ratio that measures how efficiently a company can repay it’ short-term loans within a year. Current ratio = current assets/current liabilities read more. Quick AssetsQuick AssetsQuick Assets are assets that are liquid in nature and can be converted into cash easily by liquidating them in the market. Fixed deposits, liquid funds, marketable securities, bank balances, and so on are examples.read more are the ones that can convert to cash in the short term or 90 days. The important difference between the Current Ratio formula and the Acid Test Ratio formula is that we exclude Inventory & Prepaid Expenses as a part of Current AssetsCurrent AssetsCurrent assets refer to those short-term assets which can be efficiently utilized for business operations, sold for immediate cash or liquidated within a year. It comprises inventory, cash, cash equivalents, marketable securities, accounts receivable, etc.read more in the Quick Ratio formula.

Inventory is excluded because it is assumed that the stock held by the company may not be realized immediately. Such a situation will make liquidating the inventory more tricky and time-consuming. The inventory could be in the form of Raw materials or W-I-P.

The ratio of 1 or more indicates that the company can pay off its current liabilitiesCurrent LiabilitiesCurrent Liabilities are the payables which are likely to settled within twelve months of reporting. They’re usually salaries payable, expense payable, short term loans etc.read more with the help of Quick Assets and without needing to sell its long-term assets and has sound financial health. Care must be exercised in placing too much reliance on acid test ratio without further investigating; E.g., Seasonal businesses, which seek to stabilize production, might have a weak Quick ratio during its period of slack sales, but a higher one in case of its peak business season. Such situations may prove tricky to know the company’s actual financial position.

Calculation of Quick Ratio Example

You can consider the following example for better understanding:

Masters Co. Ltd has the following details:

Current Assets:

  • Cash = $200,000Advance = $30,000Marketable SecuritiesMarketable SecuritiesMarketable securities are liquid assets that can be converted into cash quickly and are classified as current assets on a company’s balance sheet. Commercial Paper, Treasury notes, and other money market instruments are included in it.read more = $60,000Account ReceivablesAccount ReceivablesAccounts receivables is the money owed to a business by clients for which the business has given services or delivered a product but has not yet collected payment. They are categorized as current assets on the balance sheet as the payments expected within a year.
  • read more = $40,000Inventories = $80,000

Total Current Assets = $410,000

Current Liabilities:

  • Account PayableAccount PayableAccounts payable is the amount due by a business to its suppliers or vendors for the purchase of products or services. It is categorized as current liabilities on the balance sheet and must be satisfied within an accounting period.read more = $260,000,Accrual Expenses = $30,000,Short-term Debt = $90,000,Interest PayableInterest PayableInterest Payable is the amount of expense that has been incurred but not yet paid. It is a liability that appears on the company’s balance sheet.read more = $60,000.

Total Current Liabilities = $440,000.

Previous years quick ratio was 1.4 and the industry average is 1.7

Calculation of acid test ratioAcid Test RatioAcid test ratio is a measure of short term liquidity of the firm and is calculated by dividing the summation of the most liquid assets like cash, cash equivalents, marketable securities or short-term investments, and current accounts receivables by the total current liabilities. The ratio is also known as a Quick Ratio.read more formula:

Quick ratio formula = (Cash + Short-term marketable securities + A/c’s Receivable) / Current Liabilities

= ($200,000 + $60,000 + $40,000) / ($440,000)

= ($300,000) / ($440,000)

= 0.68

Uses

  • Keeping track of the Quick ratio helps the management determine whether they are maintaining optimum levels of Quick assets to take care of its short-term liabilities in their balance sheets.It showcases a well-functioning short-term financial cycle of a company.It improves the company’s credibility with the investors by gaining and maintaining their trust in the value of their investments.Also, the company’s creditors know that their payments will be made on time.

Microsoft Example

As noted from the below graph, the Cash RatioCash RatioCash Ratio is calculated by dividing the total cash and the cash equivalents of the company by total current liabilities. It indicates how quickly a business can pay off its short term liabilities using the non-current assets.read more of Microsoft is a low 0.110x; however, its quick ratio is a massive 2.216x.

source: ycharts

Microsoft’s quick ratio is pretty high, primarily due to around $106.73 billion in short-term investments! It puts Microsoft in a very comfortable position from the point of view of liquidity / Solvency.

source: Microsoft SEC Filings

  • As per the previous year, the company had an acid test ratio of 1.4, whereas this time, it amounts to 0.68.We can figure out that the company has not maintained enough Quick assets to pay off its current liabilities. It shows that the company will face potential liquidity problems.It might have to sell off its long-term assets to pay off its liabilities if needed, which is not a sign of a healthy and well-managed balance sheet.The company should maintain the acid test ratio to at least 1, which is ideal and satisfactory.

Quick Ratio Calculator

You can use the following Quick Ratio Calculator

Calculate Quick Ratio in Excel (with excel template)

Let us now do the same Quick Ratio example above in Excel.

This is very simple. You need to provide the two inputs of Total Current Assets and Total Current Liabilities.

You can easily calculate the ratio in the template provided.

Calculation of acid test ratio

Acid test ratio = (Cash + Short-term marketable securities + A/c’s Receivable) / Current Liabilities

Quick Ratio Formula Video

This article has been a guide to the Quick Ratio Formula. Here we learn how to calculate Quick Ratio with some practical Examples, calculators  You may also have a look at these articles below to learn more about Financial Analysis –

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