What the Quick Ratio Will Tell You
(includes calculator)
The quick ratio (or “acid test” ratio) provides a measure of a company’s short-term liquidity. A high ratio indicates an ability to meet short-term obligations with the liquid assets available to the company. The quick ratio, therefore, is viewed as an indication of the company’s financial strength. As the quick ratio does not include inventory in the company’s current assets, it provides a more conservative view than the current ratio (another liquidity measure). The reason it excludes inventory from the calculation is that companies may find it difficult to quickly convert their inventories to cash in the event that short-term obligations needed to be settled right away.
About Liquidity Ratios
Liquidity Ratios, derived from the balance sheet, measure the ability of the company to meet both its short and long-term obligations. In general a higher ratio value indicates the company possesses a large margin of safety to cover its debts. A company’s ability to convert short-term assets to cash to cover debts is of interest to both creditors and potential investors.
Calculating the Quick Ratio
The formula for the quick ratio is as follows:
Quick ratio = (current assets - inventories) / current liabilities
This leaves the company with the items that can be quickly converted into cash immediately.
To gather the data you will need, go to Yahoo! Finance. Enter the stock symbol in the Get Quotes box. On the lower left-hand side, click on the Balance Sheet.
A Healthy Ratio
As with any ratio analysis, the quick ratio converts financial statement numbers into valuable measures of the strengths or weaknesses of a company. A quick ratio of greater than 1 indicates an ability of the company to meet its current obligations with the funds on hand. These obligations could be met even if sales revenues ceased to exist. This ratio of 1 is considered to be satisfactory by most investors. The ratio standard can vary by industry, though, so it may be a good idea to compare the ratios of competitors within the same industry. By tracking the measure over time, you can look for negative trends that could hamper the business’ ability to meet its obligations.
More about the quick ratio
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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.
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