What is the quick ratio and how is it used? «

What is the quick ratio and how is it used?


Question: What is the quick ratio and how is it used?
Answer:
The quick ratio, sometimes called the acid-test, is a more stringent test of liquidity than the current ratio. This is because it removes inventory from the equation. Inventory is the least liquid of all the current assets. A business has to find a buyer if it wants to liquidate inventory, or turn it into cash. Finding a buyer is not always easy.

Calculation of the Quick Ratio
The quick ratio is calculated from balance sheet data.

Current Assets – Inventory/Current Liabilities

Example:

If a business firm has $200 in current assets and $50 in inventory and $100 in current liabilities, the calculation is $200-$50/$100 = 1.50X. The “X” (times) part at the end is important. It means that the firm can pay its current liabilities from its current assets (less inventory) one and a half times over.

Liquidity ratios are used to evaluate the firm’s ability to pay its short-term debt obligations such as accounts payable (payments to suppliers) and accrued taxes and wages. Short-term notes payable to a bank, for example, may also be relevant.

Interpretation and Analysis
This is obviously a good position for the firm to be in. It can meet its short-term debt obligations with no stress. If the quick ratio was less than 1.00X, then the firm would have to sell inventory to meet its obligations So, a quick ratio great than 1.00X is better than a quick ratio of less than 1.00X with regard to maintaining liquidity and not being forced into the position of having to sell inventory.

 

  • New ETFs From Scottrade - No Brokerage Fees

    There's no doubt that there are more exchange traded products now than ever.

    classy, black-and-white Corsair Graphite 600T case that says sci-fi, not hot rod. I want to get like eight of these things, ...
    Read More
  • 14 ETF Trading Strategies

    You may have heard of ETFs and some of you even have them in your portfolios, but not many investors are aware of the diverse ETF trading strategies these assets have to offer.

    Read More