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Quick Ratio, Acid Test

Definition:

The quick ratio is also known as the acid test, it is another measure of a company’s liquidity. It measures the most easily liquidated portions of the current assets, cash, cash equivalents, and accounts receivable against the current liabilities. People use it to understand if things got really ugly, could you pay off all your current liabilities?  The quick ratio is one of the liquidity ratios which tell you about a company’s ability to meet all its financial obligations, including debt, payroll, payments to vendors, taxes, and so on.

Example:

Using the Balance Sheet, the formula for calculating the quick ratio is:

Quick Ratio Formula

Amounts shown in thousands (000’s).  

For example, if your current assets for the period are $829,544, inventory is $16,798, and your current liabilities are $398,565, your quick ratio would be:

Quick Ratio Example

Book Excerpt:

(Excerpts from Financial Intelligence, Chapter 23 – Liquidity Ratios)

Most receivables, for example, will be paid in a month or two, so they’re almost as good as cash.  The quick ratio shows how easy it would be for a company to pay off its short-term debt without waiting to sell off inventory or convert it into product.  Any business that has a lot of cash tied up in inventory has to know that lenders and vendors will be looking at its quick ratio – and will be expecting it (in most cases) to be significantly above 1.

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