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What Is Quick Ratio

what is quick ratio

Definition of Quick Ratio

  • The quick ratio is a liquidity ratio that measures a firm’s ability to pay its short term liabilities with its most liquid assets.
  • Unlike the current ratio, the quick ratio is only calculated using the most liquid assets.
  • The ideal current ratio is 1:1.
  • The higher the ratio, the safer is the firm as that would mean they have excess cash.
  • However, if the ratio is too high, the firm has too much cash and should utilize it.

What is the Formula for the Quick Ratio?

  • The quick ratio can be calculated in two methods.
  • The first method is by adding Cash & equivalents, Marketable securities, Accounts receivable, and diving them by current liabilities.

Quick ratio = (Cash & equivalents + Marketable securities + Accounts receivable)/ Current liabilities 

  • The second method is by subtracting inventory and prepaid expenses from current assets and dividing them by current liabilities.

Quick ratio = (Current asset – Inventory – Prepaid expense )/ Current liabilities

The Quick Ratio in Practice

  • Assume that bleu waters has:
  • Current assets:
    • Cash $ 30,000
    • Account receivable $20,000
    • Marketable security $20,000
    • Prepaid expense $15,000
    • Inventory $15,000
  • Current liabilities:
    • Account payable $50,000
    • Term debt $30,000
  • Bleu waters’ quick ratio is:
    • ($ 30,000 + $20,000 + $20,000)/($50,000 + $30,000)= 0.875 OR
    • ($100,000 $15,000 $15,000)/ ($50,000 + $30,000)= 0.875
  • The ratio indicates that the firm does not have enough liquid assets (cash) to pay for the current liabilities.