Quick Ratio

The tougher, meaner, leaner liquidity brother of the current ratio

I like to think of the Quick Ratio as the more precise / exacting brother to the current ratio.

He's not prepared to accept loose woolly prospects of inventory being realised in a timely or fully valued way and because of this he ignores it altogether.

As short term liquidity ratios go, it's hard to beat, and therefore flushes out fat bloated companies riding along on their inventories.

This ratio is regularly used by lenders and investors when assessing working capital, and the short term viability of businesses.

Using an extract of this example balance sheet we can compute:

Quick Ratio = (Current Assets-Inventories) / Current Liabilities

From the figures above, we can compute the ratio to be:

($180,521-$119,543) / $66448 = 0.92 times

Ideally, you're looking for a value over 1 and preferably 1.25 to 1.5 You can see in this example that this liquidity ratio is under 1, and it's no surprise when you look at the balance of current assets and the valuation of the inventory.

Some manufacturing companies have very long production processes, and need large amounts of raw materials and work-in-progress to keep plant and machinery running.

In our example, the business may, or may not continue to trade with this level of liquidity, so it pays to benchmark against industry norms.

It also pays to study the ratio across different time periods for the same business, this way you can spot trends and deterioration, and then make suitable plans.

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More Accounting Formulas

Using Financial Ratio Analysis to improve your business.

Place your emphasis on working capital management and get your operations working for you and not against you.

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