Understanding Quick Ratio
The quick ratio is calculated by dividing quick assets by current liabilities. Quick assets are those assets that can be converted quickly into cash. It indicates whether the company can pay its current short-term obligations or not using its quick assets. This metric is an improved version of the current ratio. And it is used as a complementary ratio to the current ratio. While calculating the quick ratio it includes quick assets like cash, marketable investments, debtors, and bills receivable which can easily convert into cash. Quick Ratio is also known as 'liquid ratio' and 'acid test ratio'.
The formula to derive Quick Ratio
Quick Assets -
These are the assets owned by the company that can easily convert into cash. Some quick assets are cash deposits, accounts receivable, short-term loans and advances, marketable securities, etc. It is calculated by subtracting inventories from current assets.
Current Liabilities -
These are a company's debt obligations that are due to be paid within one year. Some current liabilities are accounts payables, short-term debts, outstanding expenses, etc. Current liabilities are found in the liabilities section of the company's Balance Sheet.
Example of Quick Ratio:
For the financial year, PI Industries reported Quick assets as Rs. 3440.30 and Current Liabilities as Rs. 1257.
The value as per the formula (Quick Assets / Current Liabilities) is calculated as (3440.30/1257) = 2.74.
The quick ratio is calculated as quick assets divided by current liabilities.
Quick Ratio is also known as 'liquid ratio' and 'acid test ratio'.
For better analysis, compare the company with its industry peers.
A high ratio indicates that the company can meet its current obligations immediately by quick assets.
While looking at the Quick Ratio, the following points should also take into consideration:
The ideal Quick Ratio is 1:1. A high ratio indicates that the company can meet its current obligations immediately by quick assets. If the particular company's quick ratio is one, then it shows that for every rupee of liabilities, there is one rupee of quick assets.
A low quick ratio indicates that the company cannot pay off its current debts using company quick assets.
It only considers assets that can be easily converted into cash in a short- time. The current ratio considers additional factors like inventories, which are difficult to convert into cash.
How to use Quick Ratio effectively
Investors should look for a higher ratio than one. It indicates that the company has enough or more than enough quick assets that can easily be converted if needed to pay current liabilities.
Many investors look for companies that have a focus on maintaining adequate leverage against liquidity risk by keeping the ideal range of quick ratio.
The ideal quick ratio is one for most industries, but it also differs from industry to industry. For better analysis, compare the company with its industry peers.
For better analysis, look at other financial ratios relative to Quick Ratio like Current Ratio
, Account Receivable Turnover Ratio
, Short-Term Debt to Equity Ratio
||Screener at TSR
|| Strong Bullish
||Excessive Liquid Assets
|2 to 5
||Surplus Liquid Assets
|1.5 to 2
|| Mild Bullish
||Sufficient Liquid Assets
|1 to 1.5
||Adequate Liquid Assets
|0.5 to 1
|| Mild Bearish
||Insufficient Liquid Assets
|0 to 0.5
||Shortfall in Liquid Assets
|| Strong Bearish
||Unavailability of Liquid Assets
Related Quick Ratio Screener