Quick Ratio
A quick ratio, commonly known as the acid test ratio, is a financial indicator to define the solvency of a company in the short run. And the quick ratio calculator provides assistance in measuring such solvency. It is comparatively better than the current ratio in various aspects. A current ratio compares cash and cash equivalents with inventory on the same platform. While quick ratio does not consider assets that are less liquid such as prepaid expenses and inventories.
Banks do look for a quick ratio with a current ratio as it gives an actual liquidity position of the company. A ratio of 1:1 is an ideal quick ratio. This implies that the company has enough quick current assets to pay off its current liabilities.
The quick ratio is a further narrowed-down version of the current ratio. And this pinpoints the instant liquidity status of the company. Moreover, it is a comparatively better appraisal metric to understand the cash and liability mismatch, if any.
Formula
By tweaking the current ratio, we can calculate the quick ratio. It is an easy-to-go formula if the values are already known.
- Current assets
- Current liabilities
- Bank overdraft
- Cash credit
- Prepaid expenses
- Inventories
Quick Ratio = Quick Current Assets / Quick Current Liabilities OR
Quick Ratio = Current Assets less inventories and all other non-cash equivalents / Quick current liabilities.
About the Calculator / Features
Quick ratio calculator is a quick and handy online tool made to help users instantly calculate the quick ratio rather than do the manual calculation. They have to simply insert the following figure into it.
- Quick current asset
- Quick current liabilities
Calculator
How to Calculate using Calculator
The quick ratio calculator provides an effortless calculation with a simple click after entering the following data into it.
Quick Current Assets
Inventory and prepaid expenses do not form a part of quick assets as they are comparatively less liquid in nature. Quick assets can be easily transformed into cash without lowering their value. The formula for calculating quick current assets is:
Quick Current Assets = Current Assets – Inventory – Prepaid Expenses.
The reason for excluding inventory and prepaid expenses from quick assets is that both of these do not provide actual liquidity. Inventories cannot be converted into cash immediately. They have to go through the route of debtors in order to attain liquidity which can be a time-consuming process. Same way, prepaid expenses are those expenses that are paid in advance. That is before the expenses are incurred. But the benefits of such expenses are enjoyed at a later date. Moreover, these are the expenses already incurred, and they will not affect the cash flow anymore. And hence, both of these are excluded from the calculation of quick current assets.
Quick Current Liabilities
Current liabilities are all the liabilities and payments which fall due and need to pay within the accounting year. In other words, all that is payable in less than a year are treated as current liabilities. Anything payable beyond one year, i.e., beyond one year as on the date of the balance sheet, is not part of the current liabilities. To arrive at the quantum of Quick Current Liabilities, we need to exclude Bank Overdraft and Cash Credit from the given amount of Current Liabilities. The formula is as follows:
Quick Current Liabilities = Current Liabilities – Bank Overdraft – Cash Credit.
The reason to exclude both of these items for calculating quick liabilities is that both such liabilities occur in order to buy inventories or pay off creditors.
A point to note here is that these two items are excluded only when these sources have become a permanent source of funding as an ongoing business. If these are not going to continue on a regular basis, then, in that case, they will not be deducted.
All values required for calculations of quick assets and quick liabilities are easily available on the balance sheet of the company.
Example of Quick Ratio
Example 1: The following is the data of XYZ Ltd.
| Current Assets | ($) | Current Liabilities | ($) |
| Inventories | 15,500 | Bank Overdraft | 2,000 |
| Accounts Receivables | 23,000 | Accounts Payables | 23,500 |
| Cash | 8,000 | Cash Credit | 1,500 |
| Marketable Securities | 5,000 | ||
| Prepaid Expenses | 3,000 | ||
| Total Current Assets | 54,500 | Total Current Liabilities | 27,000 |
Calculation of Quick Assets = 54,500 – 15,500 – 3,000 = 36,000
Calculation of Quick Liabilities = 27,000 – 1,500 – 2,000 = 23,500
Quick Ratio = 36,000 / 23,500 = 1.53
Let us take another example for more clarity
Example 2: Consider the following details of ABC Ltd.
| Current Assets | ($) | Current Liabilities | ($) |
| Inventories | 27,000 | Bank Overdraft | 7,500 |
| Accounts Receivables | 47,080 | Accounts Payables | 31,200 |
| Cash in Hand | 50,000 | Cash Credit | 8,000 |
| Marketable Securities | 9,000 | ||
| Prepaid Expenses | 6,500 | ||
| Total Current Assets | 139,580 | Total Current Liabilities | 46,700 |
Calculation of Quick Assets = 139,580 – 27,000 – 6,500 = 106,080
Calculation of Quick Liabilities = 46,700 – 7,500 – 8,000 = 31,200
Quick Ratio = 106,080 / 31,200 = 3.4
Interpretation
As stated above, the ideal quick ratio is 1:1, which means the quick assets are equal to quick liabilities; hence, there would be no hurdle in paying off the quick liabilities. In example 1 above, the quick ratio is equal to 1.53, which means XYZ Ltd. has enough of quick assets to meet its quick liabilities. No worries about missing any payments.
But, take the case of example 2, where the quick ratio is equal to 3.4, which is very high than the ideal ratio. This implies that funds are unnecessarily blocked in quick assets. And that can be utilized more gainfully.
Cautions
A company is required to maintain its quick ratio equal to or more than 1 but not more than 2. Else it will result in blockage of funds. In the 2nd example, the ratio is quite high at 3.4. The company should think of proper deployment of these excess blocked funds to earn out it. If there is no opportunity, then it should explore the possibilities of redeeming part of the loans to save the interest cost. But holding it idle is, in turn, increasing its opportunity cost. There are several ways to improve a quick ratio.
Another important point to note is that though the 1:1 quick ratio is the general norm, however, this can vary with the industry or business within which the company is operating. So this is not sacrosanct and needs to be considered together with the industry practices.
To know more about interpreting and improving quick ratios, refer to the article: How to Analyze (Interpret) and Improve Quick Ratio?
