How To Calculate Quick Ratio

The quick ratio is cash plus receivables divided by current liabilities. A business with two hundred and thirty thousand of quick assets against three hundred thousand of liabilities has a quick ratio of zero point seven seven, which means it cannot clear its short-term obligations without converting something that is not already cash.

The measure is also called the acid test, and the name captures its purpose: it is deliberately pessimistic. It assumes the least liquid current asset, inventory, is worth nothing in a hurry, because in an emergency stock is the hardest asset to turn into cash at close to book value.

The current ratio includes inventory and prepayments, and it is always the higher of the two. In the worked example the current ratio is one point five five against a quick ratio of zero point seven seven, and that gap is the share of current assets that would be stuck if the business had to pay quickly.

Quick assets are the ones convertible within days. Cash and equivalents are already there. Trade receivables convert on their normal collection terms. Short-term marketable securities can usually be sold without a material loss, so they count too.

Inventory is excluded for a good reason. Selling a warehouse full of stock at short notice means discounts, fire-sale pricing and time, none of which is compatible with paying a supplier next Tuesday. Including it flatters the ratio in exactly the situation where the flattery matters most.

Prepayments are also excluded, because they are already spent. A prepaid insurance premium or a licence is not something that can be called back, so it cannot contribute to settling a liability even though it is a current asset on the balance sheet.

A quick ratio below one is not automatically a problem. A supermarket chain runs on continuous stock turnover and negative working capital, so a low quick ratio is normal there, while a software business with no stock should have a quick ratio well above one.

The ratio is always compared with the sector and with the same business over time. A sudden fall usually means cash has been replaced by receivables, which is a collections problem, or by inventory, which is a demand problem.

Not all current liabilities are equally urgent. Some current liabilities, such as a current portion of long-term debt, are scheduled rather than calls for cash, so a stricter version of the ratio separates out the genuinely immediate obligations.

The denominator matters as much as the numerator. A business that has renegotiated supplier terms to ninety days has improved its quick ratio without doing anything else, which is a legitimate but easily reversed improvement.

Finally, the quick ratio is a snapshot at a point in time, while liabilities mature over the following year. A healthy ratio at the year end can hide a bad quarter in between, so it is best read alongside a cash flow forecast rather than alone.