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Making a Risk Management Plan for Your Business
It’s impossible to eliminate all business risk. Therefore, it’s essential for having a plan for its management. You’ll be developing one covering compliance, environmental, financial, operational and reputation risk management. These guidelines are for making a risk management plan for your business.
Developing Your Executive Summary
When you start the risk management plan with an executive summary, you’re breaking apart what it will be compromised of into easy to understand chunks. Even though this summary is the project’s high-level overview, the goal is describing the risk management plan’s approach and scope. In doing so, you’re informing all stakeholders regarding what to expect when they’re reviewing these plans so that they can set their expectations appropriately.
Who Are the Stakeholders and What Potential Problems Need Identifying?
During this phase of making the risk management plan, you’re going to need to have a team meeting. Every member of the team must be vocal regarding what they believe could be potential problems or risks. Stakeholders should also be involved in this meeting as well to help you collect ideas regarding what could become a potential risk. All who are participating should look at past projects, what went wrong, what is going wrong in current projects and what everyone hopes to achieve from what they learned from these experiences. During this session, you’ll be creating a sample risk management plan that begins to outline risk management standards and risk management strategies.
Evaluate the Potential Risks Identified
A myriad of internal and external sources can pose as risks including commercial, management and technical, for example. When you’re identifying what these potential risks are and have your list complete, the next step is organizing it according to importance and likelihood. Categorize each risk according to how it could impact your project. For example, does the risk threaten to throw off timelines or budgets? Using a risk breakdown structure is an effective way to help ensure all potential risks are effectively categorized and considered. Use of this risk management plan template keeps everything organized and paints a clear picture of everything you’re identifying.
Assign Ownership and Create Responses
It’s essential to ensure a team member is overseeing each potential risk. That way, they can jump into action should an issue occur. Those who are assigned a risk, as well as the project manager, should work as a team to develop responses before problems arise. That way, if there are issues, the person overseeing the risk can refer to the response that was predetermined.
Have a System for Monitoring
Having effective risk management companies plans includes having a system for monitoring. It’s not wise to develop a security risk management or compliance risk management plan, for example, without having a system for monitoring. What this means is there’s a system for monitoring in place to ensure risk doesn’t occur until the project is finished. In doing so, you’re ensuring no new risks will potentially surface. If one does, like during the IT risk management process, for example, your team will know how to react.
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What Is the Quick Ratio?
- How It Works
Quick Ratio vs. Current Ratio
- Pros and Cons
- Quick Ratio FAQs
The Bottom Line
Financial Ratios
Quick Ratio Formula With Examples, Pros and Cons
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Investopedia / Madelyn Goodnight
The quick ratio is an indicator of a company’s short-term liquidity position and measures a company’s ability to meet its short-term obligations with its most liquid assets.
Since it indicates the company’s ability to instantly use its near-cash assets (assets that can be converted quickly to cash) to pay down its current liabilities, it is also called the acid test ratio . An "acid test" is a slang term for a quick test designed to produce instant results.
Key Takeaways
- The quick ratio measures a company's capacity to pay its current liabilities without needing to sell its inventory or obtain additional financing.
- The quick ratio is considered a more conservative measure than the current ratio, which includes all current assets as coverage for current liabilities.
- The quick ratio is calculated by dividing a company's most liquid assets like cash, cash equivalents, marketable securities, and accounts receivables by total current liabilities.
- Specific current assets such as prepaids and inventory are excluded as those may not be as easily convertible to cash or may require substantial discounts to liquidate.
- The higher the ratio result, the better a company's liquidity and financial health; the lower the ratio, the more likely the company will struggle with paying debts.
What Is The Quick Ratio?
Understanding the quick ratio.
The quick ratio measures the dollar amount of liquid assets available against the dollar amount of current liabilities of a company. Liquid assets are those current assets that can be quickly converted into cash with minimal impact on the price received in the open market, while current liabilities are a company's debts or obligations that are due to be paid to creditors within one year.
A result of 1 is considered to be the normal quick ratio. It indicates that the company is fully equipped with exactly enough assets to be instantly liquidated to pay off its current liabilities. A company that has a quick ratio of less than 1 may not be able to fully pay off its current liabilities in the short term, while a company having a quick ratio higher than 1 can instantly get rid of its current liabilities. For instance, a quick ratio of 1.5 indicates that a company has $1.50 of liquid assets available to cover each $1 of its current liabilities.
While such numbers-based ratios offer insight into the viability and certain aspects of a business, they may not provide a complete picture of the overall health of the business. It is important to look at other associated measures to assess the true picture of a company's financial health.
The higher the quick ratio, the better a company's liquidity and financial health, but it important to look at other related measures to assess the whole picture of a company's financial health.
Quick Ratio Formula
There's a few different ways to calculate the quick ratio. The most common approach is to add the most liquid assets and divide the total by current liabilities:
Quick Ratio = “Quick Assets” Current Liabilities \begin{aligned}&\textbf{Quick Ratio}\mathbf{=}\frac{\textbf{``Quick Assets''}}{\textbf{Current Liabilities}}\end{aligned} Quick Ratio = Current Liabilities “Quick Assets”
Quick assets are defined as the most liquid current assets that can easily be exchanged for cash. For most companies, quick assets are limited to just a few types of assets:
Quick Assets = Cash + CE + MS + NAR where: CE = Cash equivalents MS = Marketable securities NAR = Net accounts receivable \begin{aligned}&\textbf{Quick Assets}\mathbf{=}\textbf{Cash}\mathbf{+}\textbf{CE}\mathbf{+}\textbf{MS}\mathbf{+}\textbf{NAR}\\&\textbf{where:}\\&\text{CE}=\text{Cash equivalents}\\&\text{MS}=\text{Marketable securities}\\&\text{NAR}=\text{Net accounts receivable}\end{aligned} Quick Assets = Cash + CE + MS + NAR where: CE = Cash equivalents MS = Marketable securities NAR = Net accounts receivable
Depending on what type of current assets a company has on its balance sheet, a company may also calculate quick assets by deducting illiquid current assets from its balance sheet. For example, consider that inventory and prepaid expenses may not be easily or quickly converted to cash, a company may calculate quick assets as follows:
Quick Assets = TCA − Inventory − PE where: TCA = Total current assets PE = Prepaid expenses \begin{aligned}&\textbf{Quick Assets}\mathbf{=}\textbf{TCA}\mathbf{-}\textbf{Inventory}\mathbf{-}\textbf{PE}\\&\textbf{where:}\\&\textbf{TCA}=\text{Total current assets}\\&\textbf{PE}=\text{Prepaid expenses}\end{aligned} Quick Assets = TCA − Inventory − PE where: TCA = Total current assets PE = Prepaid expenses
Regardless of which method is used to calculate quick assets, the calculation for current liabilities is the same as all current liabilities are included in the formula.
Components of the Quick Ratio
Cash is among the more straight-forward pieces of the quick ratio. A company should strive to reconcile their cash balance to monthly bank statements received from their financial institutions. This cash component may include cash from foreign countries translated to a single denomination.
Cash Equivalents
Cash equivalents are often an extension of cash as this account often houses investments with very low risk and high liquidity. Cash equivalents often include but may not necessarily be limited to Treasury bills, certificates of deposits (being mindful of options/fees to break the CD), bankers' acceptances, corporate commercial paper, or other money market instruments.
In publication by the American Institute of Certified Public Accountants (AICPA), digital assets such as cryptocurrency or digital tokens may not be reported as cash or cash equivalents.
Marketable Securities
Marketable securities , are usually free from such time-bound dependencies. However, to maintain precision in the calculation, one should consider only the amount to be actually received in 90 days or less under normal terms. Early liquidation or premature withdrawal of assets like interest-bearing securities may lead to penalties or discounted book value.
Net Accounts Receivable
Whether accounts receivable is a source of quick, ready cash remains a debatable topic, and depends on the credit terms that the company extends to its customers. A company that needs advance payments or allows only 30 days to the customers for payment will be in a better liquidity position than a company that gives 90 days.
On the other hand, a company could negotiate rapid receipt of payments from its customers and secure longer terms of payment from its suppliers, which would keep liabilities on the books longer. By converting accounts receivable to cash faster, it may have a healthier quick ratio and be fully equipped to pay off its current liabilities.
The total accounts receivable balance should be reduced by the estimated amount of uncollectible receivables. As the quick ratio only wants to reflect the cash that could be on hand, the formula should not include any receivables a company does not expect to receive.
Current Liabilities
The quick ratio pulls all current liabilities from a company's balance sheet as it does not attempt to distinguish between when payments may be due. The quick ratio assumes that all current liabilities have a near-term due date. Total current liabilities are often calculated as the sum of various accounts including accounts payable, wages payable, current portions of long-term debt, and taxes payable.
Because prepaid expenses may not be refundable and inventory may be difficult to quickly convert to cash without severe product discounts, both are excluded from the asset portion of the quick ratio.
The quick ratio is more conservative than the current ratio because it excludes inventory and other current assets, which are generally more difficult to turn into cash. The quick ratio considers only assets that can be converted to cash in a short period of time. The current ratio, on the other hand, considers inventory and prepaid expense assets. In most companies, inventory takes time to liquidate, although a few rare companies can turn their inventory fast enough to consider it a quick asset. Prepaid expenses, though an asset, cannot be used to pay for current liabilities, so they're omitted from the quick ratio.
Advantages and Limitations of the Quick Ratio
The quick ratio has the advantage of being a more conservative estimate of how liquid a company is. Compared to other calculations that include potentially illiquid assets, the quick ratio is often a better true indicator of short-term cash capabilities.
The quick ratio is also fairly easy and straightforward to calculate. It's relatively easy to understand, especially when comparing a company's liquidity against a target calculation such as 1.0. The quick ratio can be used to analyze a single company over a period of time or can be used to compare similar companies.
There are several downsides to the quick ratio. The financial metric does not give any indication about a company's future cash flow activity. Though a company may be sitting on $1 million today, the company may not be selling a profitable good and may struggle to maintain its cash balance in the future. There are also considerations to make regarding the true liquidity of accounts receivable as well as marketable securities in some situations.
Quick Ratio
Conservative approach on estimating a company's liquidity
Relatively straightforward to calculate
All components are reported on a company's balance sheet
Can be used to compare companies across time periods or sectors
Does not consider future cash flow capabilities of the company
Does not consider long-term liabilities (some of which may be due as early as 12 months from now)
May overstate the true collectability of accounts receivable
May overstate the true liquidity of marketable securities during economic downturns
Example of the Quick Ratio
Publicly traded companies generally report the quick ratio figure under the “Liquidity/Financial Health” heading in the “Key Ratios” section of their quarterly reports.
Below is the calculation of the quick ratio based on the figures that appear on the balance sheets of two leading competitors operating in the personal care industrial sector, P&G and J&J, for the fiscal year ending in 2021.
With a quick ratio of over 1.0, Johnson & Johnson appears to be in a decent position to cover its current liabilities as its liquid assets are greater than the total of its short-term debt obligations. Procter & Gamble, on the other hand, may not be able to pay off its current obligations using only quick assets as its quick ratio is well below 1, at 0.45. This shows that, disregarding profitability or income, Johnson & Johnson appears to be in better short-term financial health in respects to being able to meet its short-term debt requirements.
Why Is It Called the Quick Ratio?
The quick ratio looks at only the most liquid assets that a company has available to service short-term debts and obligations. Liquid assets are those that can quickly and easily be converted into cash in order to pay those bills.
Why Is the Quick Ratio Important?
The quick ratio communicates how well a company will be able to pay its short-term debts using only the most liquid of assets. The ratio is important because it signals to internal management and external investors whether the company will run out of cash. The quick ratio also holds more value than other liquidity ratios such as the current ratio because it has the most conservative approach on reflecting how a company can raise cash.
Is a Higher Quick Ratio Better?
In general, a higher quick ratio is better. This is because the formula's numerator (the most liquid current assets) will be higher than the formula's denominator (the company's current liabilities). A higher quick ratio signals that a company can be more liquid and generate cash quickly in case of emergency.
Keep in mind that a very high quick ratio may not be better. For example, a company may be sitting on a very large cash balance. This capital could be used to generate company growth or invest in new markets. There is often a fine line between balancing short-term cash needs and spending capital for long-term potential.
How Do the Quick and Current Ratios Differ?
The quick ratio only looks at the most liquid assets on a firm's balance sheet, and so gives the most immediate picture of liquidity available if needed in a pinch, making it the most conservative measure of liquidity. The current ratio also includes less liquid assets such as inventories and other current assets such as prepaid expenses.
What Happens If the Quick Ratio Indicates a Firm Is Not Liquid?
In this case, a liquidity crisis can arise even at healthy companies—if circumstances arise that make it difficult to meet short-term obligations such as repaying their loans and paying their employees or suppliers. One example of a far-reaching liquidity crisis from recent history is the global credit crunch of 2007-08, where many companies found themselves unable to secure short-term financing to pay their immediate obligations. If new financing cannot be found, the company may be forced to liquidate assets in a fire sale or seek bankruptcy protection.
A company can't exist without cashflow and the ability to pay its bills as they come due. By measuring its quick ratio, a company can better understand what resources they have in the very short-term in case they need to liquidate current assets. Though other liquidity ratios measure a company's ability to be solvent in the short-term, the quick ratio is among the most aggressive in deciding short-term liquidity capabilities.
AICPA. " Accounting For and Auditing of Digital Assets ."
Procter & Gamble. " 2021 Annual Report ," Page 60.
Johnson & Johnson. " 2021 Annual Report ," Page 55.
- Guide to Financial Ratios 1 of 31
- What Is the Best Measure of a Company's Financial Health? 2 of 31
- What Financial Ratios Are Used to Measure Risk? 3 of 31
- Profitability Ratios: What They Are, Common Types, and How Businesses Use Them 4 of 31
- Understanding Liquidity Ratios: Types and Their Importance 5 of 31
- What Is a Solvency Ratio, and How Is It Calculated? 6 of 31
- Solvency Ratios vs. Liquidity Ratios: What's the Difference? 7 of 31
- Key Ratio 8 of 31
- Multiples Approach 9 of 31
- Return on Assets (ROA): Formula and 'Good' ROA Defined 10 of 31
- How Return on Equity Can Help Uncover Profitable Stocks 11 of 31
- Return on Investment (ROI): How to Calculate It and What It Means 12 of 31
- Return on Invested Capital: What Is It, Formula and Calculation, and Example 13 of 31
- EBITDA Margin: What It Is, Formula, How to Use It 14 of 31
- What is Net Profit Margin? Formula for Calculation and Examples 15 of 31
- Operating Margin: What It Is and the Formula for Calculating It, With Examples 16 of 31
- Current Ratio Explained With Formula and Examples 17 of 31
- Quick Ratio Formula With Examples, Pros and Cons 18 of 31
- Cash Ratio: Definition, Formula, and Example 19 of 31
- Operating Cash Flow (OCF): Definition, Types, and Formula 20 of 31
- Receivables Turnover Ratio Defined: Formula, Importance, Examples, Limitations 21 of 31
- Inventory Turnover Ratio: What It Is, How It Works, and Formula 22 of 31
- Working Capital Turnover Ratio: Meaning, Formula, and Example 23 of 31
- Debt-to-Equity (D/E) Ratio Formula and How to Interpret It 24 of 31
- Total-Debt-to-Total-Assets Ratio: Meaning, Formula, and What's Good 25 of 31
- Interest Coverage Ratio: Formula, How It Works, and Example 26 of 31
- Shareholder Equity Ratio: Definition and Formula for Calculation 27 of 31
- Can Investors Trust the P/E Ratio? 28 of 31
- Using the Price-to-Book (P/B) Ratio to Evaluate Companies 29 of 31
- Price-to-Sales (P/S) Ratio: What It Is, Formula To Calculate It 30 of 31
- Price-to-Cash Flow (P/CF) Ratio? Definition, Formula, and Example 31 of 31
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Financial Management
Quick Ratio: How to Calculate & Examples
Even well-run businesses may experience unforeseen cash flow issues that require them to sell assets to cover expenses — after all, revenue is rarely static month to month, and disasters happen. But how do you as a business leader or potential investor know how selling an asset, like securities or accounts receivable, will affect your financial standing?
The quick ratio is one way to measure a business’s ability to quickly convert short-term assets into cash. Also known as the “acid test ratio,” the quick ratio is an indicator of a company’s liquidity and financial health.
What Is Quick Ratio?
What if a company needs quick access to more cash than it has on hand to meet financial obligations? Perhaps a hurricane knocked out power for several days, forcing the business to close its doors and lose sales, or maybe a customer is late making a large payment — but payroll still needs to be run, and invoices continue to flow in.
Most businesses experience sporadic cash flow problems . The quick ratio measures a company’s ability to convert liquid assets into cash to pay for short-term expenses and weather emergencies like these.
Key Takeaways
- The quick ratio measures a company’s ability to quickly convert liquid assets into cash to pay for its short-term financial obligations.
- A positive quick ratio can indicate the company’s ability to survive emergencies or other events that create temporary cash flow problems.
- Lenders and investors use the quick ratio to help decide whether a business is a good bet for a loan or investment.
- The quick ratio is considered a conservative measure of liquidity because it excludes the value of inventory. Thus it’s best used in conjunction with other metrics, such as the current ratio and operating cash ratio.
Quick Ratio Explained
The quick ratio represents the extent to which a business can pay its short-term obligations with its most liquid assets. In other words, it measures the proportion of a business’s current liabilities that it can meet with cash and assets that can be readily converted to cash.
The quick ratio is also known as the acid test ratio, a reference to the fact that it’s used to measure the financial strength of a business. A business with a negative quick ratio is considered more likely to struggle in a crisis, whereas one with a positive quick ratio is more likely to survive.
Quick Ratio Formula
The quick ratio formula is:
Quick ratio = quick assets / current liabilities
Quick assets are a subset of the company’s current assets. You can calculate their value this way:
Quick assets = cash & cash equivalents + marketable securities + accounts receivable
If it’s not possible to identify all of these individual asset types on the balance sheet, the total value of quick assets can be deduced from the value of current assets using this formula:
Quick assets = current assets – inventory – prepaid expenses
You can find the value of current liabilities on the company’s balance sheet.
What Is Included in the Quick Ratio?
The quick ratio is the value of a business’s “quick” assets divided by its current liabilities. Quick assets include cash and assets that can be converted to cash in a short time, which usually means within 90 days. These assets include marketable securities, such as stocks or bonds that the company can sell on regulated exchanges. They also include accounts receivable — money owed to the company by its customers under short-term credit agreements.
Why isn’t inventory included?
Stock, whether clothing for a retailer or automobiles for a car dealer, is not included in the quick ratio because it may not be easy or fast to convert your inventory into cash quickly without significant discounts. The quick ratio also doesn’t include prepaid expenses, which, though short-term assets, can’t be readily converted into cash.
Quick Ratio vs Current Ratio
The quick ratio is one way to measure business liquidity. Another common method is the current ratio. Whereas the quick ratio only includes a company’s most highly liquid assets, like cash, the current ratio factors in all of a company’s current assets — including those that may not be as easy to convert into cash, such as inventory. Both ratios compare assets against the business’s current liabilities.
Current liabilities are defined as all expenses a business is due to pay within one year. The category can include short-term debts, accounts payable and accrued expenses, which are debits that the company has recognized on the balance sheet but hasn’t yet paid.
Quick Ratio Analysis
The quick ratio measures a company’s ability to raise cash quickly when needed. For investors and lenders, it’s a useful indicator of a company’s resilience. For business managers, it’s one of a suite of liquidity measures they can use to guide business decisions, often with help from their accounting partner .
Other important liquidity measures include the current ratio and the cash ratio.
The quick ratio is a stricter measure of liquidity than the current ratio because it includes only cash and assets the company can quickly turn into cash. However, the quick ratio is not as strict a measure as the cash ratio, which measures the ratio of cash and cash equivalents to current liabilities. Unlike the quick ratio, the cash ratio excludes accounts receivable.
The quick ratio also doesn’t say anything about the company’s ability to meet obligations from normal cash flows. It measures only the company’s ability to survive a short-term interruption to normal cash flows or a sudden large cash drain.
How to Calculate Quick Ratio
Financial managers can calculate their company’s quick ratio by identifying the relevant assets and liabilities in the company’s accounting system . Investors and lenders can calculate a company’s quick ratio from its balance sheet. Here’s how:
- From the balance sheet, find cash and cash equivalents, marketable securities and accounts receivable, which you’ll sometimes see listed as “trade debtors” or “trade receivables.” These are the quick assets.
- On the balance sheet, find “current liabilities.”
- Add up the quick assets. Then divide them by current liabilities.
The result is the quick ratio.
Quick Ratio Examples
Company A has a balance sheet that looks like this:
This company’s current assets consist entirely of quick assets, so calculating the quick ratio is straightforward:
Quick ratio = quick assets / current liabilities = 165,000/137,500 = 1.2
In contrast, Company B has a balance sheet that looks like this:
Company B’s total current assets include inventory and prepaid expenses, which are not part of the quick ratio. However, the quick assets are separately identified, so we can calculate the quick ratio using the extended formula:
Quick ratio = (cash & cash equivalents + marketable securities + accounts receivable) / current liabilities = (15,000 + 5,000 + 5,000)/37,500 = 25,000/37,500 = 0.67
So which company is in a better position to receive funding to cover its short-term obligations?
Why Is Quick Ratio Important?
The quick ratio is widely used by lenders and investors to gauge whether a company is a good bet for financing or investment. Potential creditors want to know whether they will get their money back if a business runs into problems, and investors want to ensure a firm can weather financial storms.
The quick ratio is an important measure of the company’s ability to meet its short-term obligations if cash flow becomes an issue.
What Is a Good Quick Ratio?
A quick ratio that is equal to or greater than 1 means the company has enough liquid assets to meet its short-term obligations.
However, an extremely high quick ratio isn’t necessarily a good sign, since it may indicate the company is sitting on a significant amount of capital that could be better invested to expand the business.
The optimal quick ratio for a business depends on a number of factors, including the nature of the industry, the markets in which it operates, its age and its creditworthiness. For example, an established business with strong supplier relationships and a good credit history may be able to operate with a significantly lower quick ratio than a startup because it’s more likely to obtain additional financing at low interest rates and/or negotiate credit extensions with suppliers in the event of an emergency.
What Does a Quick Ratio Under 1 Mean?
If a business’s quick ratio is less than 1, it means it doesn’t have enough quick assets to meet all its short-term obligations. If it suffers an interruption, it may find it difficult to raise the cash to pay its creditors.
In addition, the business could have to pay high interest rates if it needs to borrow money.
How Do Client Payments Affect a Business’s Quick Ratio?
The quick ratio includes payments owed by clients under credit agreements (accounts receivable). But it doesn’t tell us when client payments are due, which can make the quick ratio misleading as a measure of business risk.
For example, suppose Company A has current liabilities of $15,000 and quick assets comprising $1,000 cash and $19,000 of accounts receivable, with customer payment terms of 90 days. Its quick ratio is 1.33, which looks rather good.
But suppose it has a supplier payment of $5,000 falling due in 10 days. Unless a large number of its customers pay what they owe within 10 days, the company won’t have enough cash available to meet its obligation to the supplier — despite its apparently good quick ratio. It may have to look at other ways to handle the situation, such as tapping a credit line for the funds to pay the supplier or paying late and incurring a late fee.
Now consider Company B, which has current liabilities of $15,000 and quick assets comprising $10,000 cash and $4,000 of accounts receivable, with customer payment terms of 30 days. Its quick ratio is 0.93, so it looks a lot weaker than Company A.
Company B, too, has a $5,000 supplier payment falling due in 10 days. But unlike the first company, it has enough cash to meet that supplier payment comfortably — despite its lower quick ratio.
All told, client payments and supplier terms both affect a company’s ability to meet its short-term obligations. However, the quick ratio doesn’t factor in these payment terms, so it may overstate or understate a company’s real liquidity position. In addition, the quick ratio doesn’t take into account a company’s credit facilities, which can significantly affect its liquidity.
Advantages and Disadvantages of the Quick Ratio
There are a number of advantages to using the quick ratio:
- During hard times, a business’s ability to leverage its cash and other short-term assets can be key to survival. Too often, businesses facing cash flow problems have to sell inventory at a heavy discount or borrow at very high interest rates to meet immediate obligations.
- The quick ratio is a useful indicator of a company’s ability to manage cash flow problems without resorting to fire sales or borrowing money.
However, the quick ratio has several significant disadvantages.
- The quick ratio ignores supplier and customer credit terms. This can give a misleading impression of asset liquidity.
- The quick ratio doesn’t tell you anything about operating cash flows, which companies generally use to pay their bills.
- For companies that can sell inventory fast, the quick ratio can be a misleading representation of liquidity. For these companies, the current ratio — which includes inventory — may be a better measure of liquidity.
Working Capital May Be a Lifeline
Need cash fast? Working-capital financing companies may acquire some or all of a company’s accounts receivable or issue loans using the accounts receivable as collateral. There are two main models.
Accounts receivable loans:
With customer invoices as collateral, the lender gives the borrower cash or a line of credit, normally 70% to 90% of the value of the accounts receivable.
The borrower pays interest on the amount loaned. The rate depends on the lender and other factors and can vary widely, from 5% to 20%.
The credit standing of the end customer, in addition to the financial stability of the borrowing company, may affect the rate.
The borrower collects payments from customers directly and uses that cash to repay the loan.
Invoice factoring:
Differs from an accounts receivable loan in that a company sells its receivable invoices to another company (called a factor) outright.
Companies can expect between 70% and 85% of the value of the invoices but may need to pay fees that cut into that amount.
The factor then collects the invoiced amounts directly from your customers, which removes the need to chase and process payments but may have a negative effect on relationships.
Limitations of Quick Ratio
The main limitation of the quick ratio is that it assumes a company will meet its obligations using its quick assets. But generally speaking, companies aim to meet their obligations from operating cash flow, not by using their assets. The quick ratio doesn’t reflect a company’s ability to meet obligations from its operating cash flows; it only measures the company’s ability to survive a cash crunch.
Another limitation of the quick ratio is that it doesn’t consider other factors that affect a company’s liquidity, such as payment terms and existing credit facilities. As a result, the quick ratio does not provide a complete picture of liquidity. Experts recommend using it in conjunction with other metrics, such as the cash ratio and the current ratio.
Plan & Forecast More Accurately
How Your Company Can Use the Quick Ratio
In business, cash flow is king and the accounts receivable gap is real . The ability to rapidly convert assets to cash can be pivotal to help the company survive a crisis. The quick ratio provides insight into your company’s ability to sell assets if needed.
Maintaining an optimal quick ratio may also help you get favorable interest rates if you need a loan, and it can make your company more attractive to investors.
If your company’s quick ratio is below the average for your industry and market, you can improve it in a number of ways. For example, you could increase quick assets by cutting operating expenses, or you could reduce current liabilities by refinancing short-term loans with longer-term debt or negotiating better prices with suppliers.
If your company’s quick ratio is significantly above average, it suggests that you might be able to make better use of your cash by using it to fund business expansion, perhaps by increasing investments in plants or machinery, hiring more staff or acquiring another company.
To figure out the best way forward, companies often consult with managerial accountants who have experience analyzing business costs and operational metrics and using that insight to assist executives in the decision-making process.
Free Quick Ratio Template
To calculate your company’s quick ratio, download this free template.
Get the template
While the quick ratio yields insights into a company’s ability to pay its short-term financial obligations and is often used by creditors and investors to help decide whether a business is a good bet for a loan or investment, it’s not a perfect indicator. We recommend using it in conjunction with other business metrics.
Accounting software helps a company better determine its liquidity position by automating key functionality that helps monitor your business’s financial health. NetSuite Financial Management automates more accounting processes and gives you and your finance team easy access to data for analysis – with high impact functions to automate including invoicing, financial report generation, data collection and document storage, and compliance.
Cash Flow Analysis: Basics, Benefits and How to Do It
Cash flow is the amount of cash and cash equivalents, such as securities, that a business generates or spends over a set time period. Cash on hand determines a company’s runway—the more cash on hand and the lower…
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Quick Ratio
Do the company’s current assets easily cover its current liabilities?
What is the Quick Ratio?
The Quick Ratio, also known as the Acid-test or Liquidity ratio, measures the ability of a business to pay its short-term liabilities by having assets that are readily convertible into cash . These assets are, namely, cash, marketable securities, and accounts receivable . These assets are known as “quick” assets since they can quickly be converted into cash.
The Quick Ratio Formula
Quick Ratio = [C ash & equivalents + marketable securities + accounts receivable] / Current liabilities
Or, alternatively,
Quick Ratio = [Current Assets – Inventory – Prepaid expenses] / Current Liabilities
For example, let’s assume a company has:
- Cash: $10 Million
- Marketable Securities: $20 Million
- Accounts Receivable: $25 Million
- Accounts Payable: $10 Million
This company has a liquidity ratio of 5.5, which means that it can pay its current liabilities 5.5 times over using its most liquid assets. A ratio above 1 indicates that a business has enough cash or cash equivalents to cover its short-term financial obligations and sustain its operations.
The formula in cell C9 is as follows = (C4+C5+C6) / C7
This formula takes cash, plus securities, plus AR, and then divides that total by AP (the only liability in this example).
The result is 5.5.
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What’s Included and Excluded?
Generally speaking, the ratio includes all current assets, except:
- Prepaid expenses – because they can not be used to pay other liabilities
- Inventory – because it may take too long to convert inventory to cash to cover pressing liabilities
As you can see, the ratio is clearly designed to assess companies where short-term liquidity is an important factor. Hence, it is commonly referred to as the Acid Test.
The Quick Ratio In Practice
The quick ratio is the barometer of a company’s capability and inability to pay its current obligations. Investors, suppliers, and lenders are more interested to know if a business has more than enough cash to pay its short-term liabilities rather than when it does not. Having a well-defined liquidity ratio is a signal of competence and sound business performance that can lead to sustainable growth.
To learn more about this ratio and other important metrics, check out CFI’s course on performing financial analysis .
Quick Ratio vs Current Ratio
The quick ratio is different from the current ratio, as inventory and prepaid expense accounts are not considered in quick ratio because, generally speaking, inventories take longer to convert into cash and prepaid expense funds cannot be used to pay current liabilities . For some companies, however, inventories are considered a quick asset – it depends entirely on the nature of the business, but such cases are extremely rare.
Additional Resources
Thank you for reading CFI’s guide to Quick Ratio. To keep learning and advancing your career as a financial analyst, these additional CFI resources will help you on your way:
- Profitability Ratios
- Forward PE Ratio
- Analysis of Financial Statements
- Financial Modeling Best Practices Guide
- See all accounting resources
- See all capital markets resources
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A beginner's guide to quick ratio.
by Mary Girsch-Bock | Updated Aug. 5, 2022 - First published on May 18, 2022
Image source: Getty Images
There are numerous accounting ratios that can be used to determine the financial stability and credit-worthiness of your company.
One of those, the quick ratio, shows the balance between your current assets and your current liabilities, with the best result showing that current company assets outweigh current liabilities. You’ll remember from Accounting 101 that assets are anything you own and liabilities are anything you owe.
While your bookkeeper or staff accountant can certainly calculate a quick ratio, it’s best to let an experienced accountant provide the follow-up analysis on what the quick ratio results mean for your company.
Overview: What is the quick ratio?
The quick ratio, also referred to as the acid-test ratio, is considered a liquidity ratio. The quick ratio definition is simple: it calculates and measures the ability of your company to pay its current liabilities and debts.
The quick ratio is called such because it only measures liquid assets, or assets that can be quickly converted into cash. You will need to be using double-entry accounting in order to run a quick ratio.
What is a good quick ratio?
The higher your quick ratio, the better your business will be able to meet any short-term financial obligations. A quick ratio of 1 means that for every $1 in current liabilities, you have $1 in current assets.
If the quick ratio for your business is less than 1, it means that your liabilities outweigh your assets, while a quick ratio of 10 means that for every $1 in liabilities, you have $10 in liquid assets.
What’s the difference between the quick ratio vs current ratio?
While both the quick ratio and the current ratio divide assets by liabilities, they differ in the types of assets included in each formula:
- Quick ratio: The quick ratio formula uses current liquid assets, which are assets that can be turned into cash quickly, divided by current liabilities. The quick ratio does not include inventory , prepaid expenses , or supplies in its calculation.
- Current ratio: The current ratio formula is current assets divided by current liabilities, but it includes all current assets, not just liquid assets.
This is an important difference when it comes to determining the ability of your company to pay its short-term liabilities, which is what the quick ratio is designed to do.
The quick ratio formula
You will use a balance sheet in order to calculate the quick ratio.
You can obtain all the information you need to run the quick ratio from your balance sheet. Image source: Author
The quick ratio formula is:
(Cash + Marketable Securities + Accounts Receivable) ÷ Current Liabilities = Quick Ratio
Marketable securities are financial instruments that can be quickly converted to cash, such as government bonds, common stock, and certificates of deposit.
Other assets are excluded from the formula since it calculates your ability to pay debts short-term, so the formula is only concerned with assets that have liquidity.
Current liabilities are short-term debt that are typically due within a year. You should include only current liabilities in your calculation for the same reason listed above; the formula is designed to calculate the ability to pay debts short-term.
How to calculate the quick ratio
If you’re still confused about how to calculate the quick ratio, we’ll take you through the process step-by-step.
Step 1: Run a balance sheet
The most important step in the process is running your balance sheet, since you will be pulling all of your numbers from the balance sheet in order to calculate the quick ratio.
Pro Tip: It’s best to run a standard balance sheet, rather than a summary balance sheet, since the standard balance sheet provides both asset and liability details rather than only totals.
Step 2: Calculate your current assets
Remember, while you want to include current assets in your quick ratio, you only want to include liquid assets.
The standard balance sheet provides asset details. Image source: Author
Liquid assets include your cash and accounts receivable , as well as undeposited funds. You would not include inventory or prepaid expenses in the quick ratio calculation, as neither can be converted to cash quickly. To calculate your current assets you will add the following:
You would not include prepaid insurance, employee advances, and inventory assets since none of those items can be quickly converted to cash.
Pro Tip: Be sure to only include assets that can be quickly converted to cash when calculating the quick ratio.
Step 3: Calculate your current liabilities
Like your assets, you’ll only want to include your current liabilities when calculating the quick ratio.
Only current liabilities should be included in the quick ratio calculation. Image source: Author
Current liabilities include accounts payable, credit card debt, payroll , and sales tax payable, which are all payable within one year. To run the quick ratio, you can use your total current liabilities based on the balance sheet above, which is $9,440.53. Long term liabilities should be excluded.
Pro Tip: Be sure to exclude long term liabilities such as bank loans when calculating the quick ratio.
Step 4: Complete the quick ratio calculation
Using the balance sheet totals displayed in Step 2 and Step 3, the numbers you will use to calculate the quick ratio are as follows:
Current assets: $141,382.77 (Step 2)
Current liabilities: $9,440.53 (Step 3)
You can now calculate the quick ratio:
$141,382.77 ÷ $9,440.53 = 14.98
Pro Tip: Double check your numbers to ensure that only current, liquid assets and current liabilities are included in the quick ratio calculation.
How can your company use your quick ratio?
Knowing the quick ratio for your company can help you make needed adjustments such as increasing sales, or developing a more effective accounts receivable collection process.
Knowing the quick ratio can also help when you’re preparing financial projections, no matter what type of accounting your company currently uses.
Quick ratio can help your company
The quick ratio meaning is simple: does your company have enough current assets to cover its current liabilities. Calculating this ratio can be particularly valuable for those looking to obtain additional financing, as both creditors and investors will want to see how financially stable your company is before lending money.
Finally, if you’re not happy with the results of the quick ratio, you can take steps internally to begin to address the issues that may be causing a low quick ratio, such as the inability to collect on accounts receivable on a timely basis.
Like any ratio, the quick ratio is more beneficial if it’s calculated on a regular basis, so you can determine whether your number is going up down, or remaining the same.
An accurate balance sheet is the key to an accurate quick ratio. If you’re looking for accounting software to help prepare your financial statements, be sure to check out The Ascent’s accounting software reviews .
The quick ratio lets you know if your company has enough current, liquid assets to pay its short-term debts.
The quick ratio number is a ratio between assets and liabilities. For instance, a quick ratio of 1 means that for every $1 of liabilities you have, you have an equal $1 in assets. A quick ratio of 15 means that for every $1 of liabilities, you have $15 in assets.
If your quick ratio number is too low, you can reexamine company policies, work to increase sales, or institute better collection practices so you can be paid on a more timely basis.
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Our Research Expert
Mary Girsch-Bock is the expert on accounting software and payroll software for The Ascent. She previously worked as an accountant.
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Quick Ratio
Guide to Understanding the Quick Ratio Concept
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What is Quick Ratio?
The Quick Ratio measures the short-term liquidity of a company by comparing the value of its cash balance and current assets to its near-term obligations.
Otherwise referred to as the “acid test” ratio, the quick ratio is distinct from the current ratio since a more stringent criterion is applied to the current assets in its calculation.
How to Calculate Quick Ratio (Step-by-Step)
The quick ratio compares the short-term assets of a company to its short-term liabilities to evaluate if the company would have adequate cash to pay off its short-term liabilities.
Calculating the quick ratio involves dividing a company’s current cash & equivalents (e.g. marketable securities ) and accounts receivable by its current liabilities.
Conceptually, the quick ratio answers the question:
- “Does the company have enough cash to pay off its short-term liabilities, such as debt obligations soon coming due?
The core components of the metric include the following line items:
- Current Assets: Cash & Equivalents, Marketable Securities, Accounts Receivable (A/R)
- Current Liabilities: Accounts Payable (A/P), Short-Term Debt
In the calculation of the quick ratio, the items that are considered as part of current assets are under more stringent rules — which is based on the notion that certain assets are more difficult to liquidate quickly, such as inventory , or may be difficult to sell at the same or relatively similar value (i.e. in a scenario where no substantial discount is required to sell the asset ).
The inclusion of illiquid current assets within the calculation can potentially cause a misleading portrayal of the company’s financial condition, as it may misleadingly portray a company as being better able to meet its short-term obligations than in reality.
Quick Ratio Formula
The formula for calculating the quick ratio is as follows.
For example, let’s imagine that a company has the following balance sheet data:
Current Assets:
- Cash = $20 million
- Marketable Securities = $10 million
- Accounts Receivable (A/R) = $20 million
- Inventory = $40 million
Current Liabilities:
- Accounts Payables = $30 million
- Short-Term Debt = $10 million
Next, the required inputs can be calculated using the following formulas.
- Current Assets = $20 million + $10 million + $20 million = $50 million
- Current Liabilities = $30 million + $10 million = $40 million
As mentioned earlier, illiquid assets are excluded in the calculation of the quick ratio, which is why inventory is not included.
Lastly, we’ll divide the current assets by the current liabilities to arrive at the quick ratio:
- Quick Ratio = $50 million ÷ $40 million = 1.25x
Quick Ratio vs. Current Ratio: What is the Difference?
Similar to the current ratio , which also compares current assets to current liabilities, the quick ratio is categorized as a liquidity ratio.
Both liquidity ratios are calculated under a hypothetical scenario in which a company must pay off all existing current liabilities that have come due using its current assets.
However, one major difference between the two is that the quick ratio includes only the current assets that can be converted into cash within 90 days or less, whereas the current ratio includes all current assets that can be converted into cash within one year.
The quick ratio is thus considered to be more conservative than the current ratio, since its calculation intentionally ignores more illiquid items like inventory.
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How to Interpret Quick Ratio (High or Low)
While dependent on the specific industry, the quick ratio should exceed >1.0x for the vast majority of industries.
The two general rules of thumb for interpreting the quick ratio are as follows.
- Higher Ratio → Sufficient Coverage of Current Liabilities
- Lower Ratio → Insufficient Coverage of Current Liabilities
The quick ratio measures if a company, post-liquidation of its liquid current assets, would have enough cash to pay off its immediate liabilities — so, the higher the ratio, the better off the company is from a liquidity standpoint.
If the ratio is low, the company should likely proceed with some degree of caution, and the next step would be to determine how and how quickly more capital could be obtained.
For example, a company with a low ratio might not be at too much of a risk if it has non-core fixed assets on standby that could be sold relatively quickly.
In fact, such a company may be viewed favorably by the equity or debt capital markets and be able to raise capital easily.
But a higher ratio should NOT automatically be interpreted as a positive sign without further research into the company’s drivers – e.g. a company can have a healthy quick ratio of 2.0x, yet the majority of its current assets are A/R where the collection of payment from customers is not always guaranteed.
While a higher amount of asset collateral is perceived positively under a liquidation scenario, most companies focus more on forward-looking performance like free cash flow (FCF) generation and profit margins, although all of these aspects are ultimately interconnected.
Quick Ratio Calculator – Excel Template
We’ll now move to a modeling exercise, which you can access by filling out the form below.
Quick Ratio Calculation Example
Suppose a company has the following balance sheet financial data in Year 1, which we’ll use as our assumptions for our model.
- Cash & Equivalents: $20m
- Marketable Securities: $15m
- Accounts Receivable (A/R): $25m
- Inventory: $80m
- Accounts Payable: $65m
- Short-Term Debt: $85m
In Year 1, the quick ratio can be calculated by dividing the sum of the liquid assets ($20m Cash + $15m Marketable Securities + $25m A/R) by the current liabilities ($150m Total Current Liabilities).
- Quick Ratio, Year 1: $60m ÷ $150m = 0.4x
The company appears not to have enough liquid current assets to pay its upcoming liabilities.
From Year 2 to Year 4, we’ll use a step function for each B/S line item with the following assumptions.
- Cash and Cash Equivalents : +$5m
- Marketable Securities: +$2m
- Accounts Receivable (A/R): +$3m
- Inventory: +$25m
- Accounts Payable: +$5m
- Short-Term Debt: +$10m
Upon dividing the sum of the cash and cash equivalents, marketable securities, and accounts receivable balance by the total current liabilities balance, we arrive at the quick ratio for each period.
At the end of the forecast period, Year 4, our company’s ratio remains relatively unchanged at 0.5x, which is problematic as the concerns regarding short-term liquidity remain.
However, the current ratio in Year 4 is 1.3x, more than double the 0.5x ratio from earlier.
While the high inventory balance and growth benefit the current ratio, the quick ratio excludes illiquid current assets such as inventory. The gap between the current ratio and quick ratio stems from the inventory line item, which comprises a significant portion of the total current assets balance.
The inventory balance of our company expands from $80m in Year 1 to $155m in Year 4, reflecting an increase of $75m.
Our company’s current ratio of 1.3x is not necessarily positive, since a range of 1.5x to 3.0x is usually ideal, but it is certainly less alarming than a quick ratio of 0.5x.
On one note, the inventory balance can be helpful when raising debt capital (i.e. collateral ), as long as there are no existing liens placed on the inventory or any other contractual restrictions.
Yet, the broader concern here is that the cause of the accumulating inventory balance is due to declining sales or lackluster customer demand for the company’s products/services.
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- Main content
- What is quick ratio?
- Why is knowing the quick ratio important?
Quick ratio formula
Example using quick ratio.
- What's a good quick ratio?
Quick ratio vs. current ratio
- The financial takeaway
The quick ratio is a basic liquidity metric that helps determine a company's solvency
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- The quick ratio evaluates a company's ability to pay its current obligations using liquid assets.
- The higher the quick ratio, the better a company's liquidity and financial health.
- A company with a quick ratio of 1 and above has enough liquid assets to fully cover its debts.
A company's quick ratio is a measure of liquidity used to evaluate its capacity to meet short-term liabilities using its most-liquid assets. A company with a high quick ratio can meet its current obligations and still have some liquid assets remaining.
The quick ratio measures a company's ability to pay its short-term liabilities when they come due by selling assets that can be quickly turned into cash. It's also called the acid test ratio, or the quick liquidity ratio because it uses quick assets, or those that can be converted to cash within 90 days or less. This includes cash and cash equivalents, marketable securities, and current accounts receivable.
A quick ratio of 1 is considered the industry average. A quick ratio below 1 shows that a company may not be in a position to meet its current obligations because it has insufficient assets to be liquidated. This tells potential investors that the company in question is not generating enough profits to meet its current liabilities.
On the contrary, a company with a quick ratio above 1 has enough liquid assets to be converted into cash to meet its current obligations. In essence, it means the company has more quick assets than current liabilities. "The quick ratio is important as it helps determine a company's short-term solvency," says Jaime Feldman, tax manager at Fiske & Company . "It's the company's ability to pay debt due soon with assets that quickly convert to cash. You can use the quick ratio to determine a company's overall financial health."
The quick ratio is calculated by dividing the sum of a company's liquid assets by its current liabilities. This is the basic formula:
Quick assets
Quick assets are those that can be quickly turned into cash. Accounts receivable, cash and cash equivalents, and marketable securities are the most liquid items in a company.
For an item to be classified as a quick asset, it should be quickly turned into cash without a significant loss of value. In other words, a company shouldn't incur a lot of cost and time to liquidate the asset. For this reason, inventory is excluded in quick assets because it takes time to convert into cash.
Companies usually keep most of their quick assets in the form of cash and short-term investments (marketable securities) to meet their immediate financial obligations that are due in one year.
Current liabilities
Current liabilities are a company's short-term debts due within one year or one operating cycle. Accounts payable is one of the most common current liabilities in a company's balance sheet. It can also include short-term debt, dividends owed, notes payable, and income taxes outstanding.
Let's say you own a company that has $10 million in cash and cash equivalents, $30 million marketable securities, $15 million of accounts receivable, and $22 million of current liabilities. To calculate the quick ratio, divide current liabilities by liquid assets. In this case:
- Quick assets = ($10 million cash + $30 million marketable securities + $15 million accounts receivable)
- Current liabilities = $22 million
- Quick ratio = $55 million / $22 million = $2.5 million.
- The company's quick ratio is 2.5, meaning it has more than enough capital to cover its short-term debts.
A company with a quick ratio of less than 1 indicates that it doesn't have enough liquid assets to fully cover its current liabilities within a short time. The lower the number, the greater the company's risk. "A good quick ratio is very dependent on the industry of the company being represented. A good rule of thumb though is to have a quick ratio around or above 1," says Austin McDonough, an associate financial advisor at Keystone Wealth Partners . "This shows that a company has enough cash or other liquid assets to pay off any short-term liabilities in case they all come due at once."
The quick ratio and current ratio are two metrics used to measure a company's liquidity. While they might seem similar, they're calculated differently. The quick ratio yields a more conservative number as it only includes assets that can be turned into cash within a short period 一 typically 90 days or less.
Conversely, the current ratio factors in all of a company's assets, not just liquid assets in its calculation. That's why the quick ratio excludes inventory because they take time to liquidate.
The bottom line
The quick ratio evaluates a company's capacity to meet its short-term obligations should they become due. This liquidity ratio can be a great measure of a company's short-term solvency. As an investor, you can use the quick ratio to determine if a company is financially healthy. "The higher the ratio result, the better a company's liquidity and financial health is," says Jaime.
However, it's essential to consider other liquidity ratios, such as current ratio and cash ratio when analyzing a great company to invest in. This way, you'll get a clear picture of a company's liquidity and financial health.
Related articles
Current ratio vs. quick ratio: Which one is more relevant for your SaaS business
To achieve meaningful growth, SaaS firms must have a firm grip on their financials. Learn all about current and quick ratios, how to calculate them, and the key differences between current ratio vs quick ratio.
What is a current ratio?
What is a quick ratio.
- Key differences
- Who reviews the ratios
- Calculating SaaS quick ratio
- Monitor with ProfitWell Metrics
- Current vs quick ratio FAQs
Licensing flexibility, unlimited growth potential, and scalability are some of the upsides of the SaaS business model . A subscription model makes for a predictable revenue stream that allows these businesses to achieve phenomenon growth. Some SaaS firms have achieved unicorn status in five years, growing to the coveted $1B valuations.
To achieve such a meteoric rise, SaaS firms must have a firm grip on their financials. That means going beyond the typical bookkeeping and accounting processes. The use of sophisticated financial ratios such as quick and current ratios offers rarified insights into SaaS financials .
Current ratio and quick ratio are liquidity ratios that measure a company's ability to pay it's short-term debts. The primary difference between the two ratios is the time frame considered and definition of current assets.
The current ratio measures a company's ability to offset its current liabilities or short-term debts with short-term or current assets. It's also known as the working capital ratio.
What is included in the current ratio?
Current ratio calculations only use current assets , assets that can be converted into cash within a year. Likewise, current liabilities are the debts your company owes that are due and payable within a year.
The most common current assets are: account receivables, cash and cash equivalent, securities, inventory, and prepaid expenses. Current liabilities include: accrued liabilities, accounts payable, short-term debts, and other debts.
Current ratio formula
Current ratio calculations use a simple formula:
Current Ratio = Current Assets ÷ Current Liabilities
To calculate the current ratio, add up all of your firm's current assets and divide them with the total current liabilities.
For instance, if your firm's total current assets amount to $250,000 and your total current liabilities amount to $100,000. Your current ratio would be: $250k ÷ $100k = 2.5
That indicates that your firm has $2.5 worth of current assets for every dollar you have in current liabilities.
What is a good current ratio for a company?
Two is the ideal current ratio because you can easily pay off your liabilities without running into liquidity issues. Anything less than two puts your firm in the red zone. It indicates that you have a liquidity problem and don't have enough assets to pay off current debts.
A high current ratio may seem desirable, but anything above four is problematic. It indicates the firm is underutilizing its assets.
Also called the acid test ratio, a quick ratio is a conservative measure of your firm's liquidity because it uses a fraction of your current assets. Unlike current ratio, quick ratio calculations only use quick assets or short-term investments that can be liquidated to cash in 90 days or less.
What is included in the quick ratio?
You'll include cash and cash equivalent, accounts receivable, and marketable securities in your quick ratio calculations. Typically, you eliminate inventory and prepaid expenses when calculating quick ratios because you can't convert them into cash in 90 days.
However, the current liabilities remain the same and include: short-term debt, accrued liabilities, and accounts payable.
Quick ratio formula
While the quick ratio formula uses current liabilities, it scales down the assets to accommodate the short timeframe, usually about three months.
Quick Ratio = (Cash + Cash Equivalents + Liquid Securities + Receivables) ÷ Current Liabilities
From the example above, a quick recalculation shows your firm now holds $150,000 in current assets while the current liabilities remain at $100,000.
The firm's quick ratio is : 150,000 ÷ 100,000 = 1.5
After removing inventory and prepaid expenses, your business has $1.5 in assets for every dollar in liabilities, which is a great ratio.
What is a good quick ratio for a company?
A quick ratio above one is excellent because it shows an even match between your assets and liabilities. Anything less than one shows that your firm may struggle to meet its financial obligations.
If the quick ratio is too high, the firm isn't using its assets efficiently. While this formula offers insights into virtually any business vertical, it doesn't adequately describe the SaaS model.
Current ratio vs quick ratio: key differences
Both the quick and current ratios are considered liquidity ratios because they measure a firm's short-term liquidity. Since the ratios use the firm's account receivables in their calculation, they're an excellent indicator of financial health and ability to meet its debt obligations.
However, the current ratio and quick ratio have some key differences:
- Current ratio calculations include all the firm's current assets, while quick ratio calculations only include quick or liquid assets.
- The quick ratio of a company is considered conservative because it offers short-term insights (about three months), while the current ratio offers long-term insights (a year or longer).
- Quick ratio only uses quick assets and excludes any assets that can't be liquidated and converted into cash in 90 days or less. The current ratio considers all holdings that can be liquidated and converted into cash within a year.
- The quick ratio of a company excludes inventory from its calculations, while current ratio calculations include inventory.
- A 2:1 result is ideal for the current ratio, while a 1:1 is the perfect quick ratio for most businesses except SaaS.
Who reviews quick and current ratio
Since these ratios provide insights into a company's liquidity, they're reviewed by different groups of people.
- SaaS owners use these formulas to check their firm's liquidity and financial health. They can use them to identify the shortcomings and take quick corrective actions to keep the business in the green.
- Creditors use these ratios to determine a firm's credit worthiness. Ideal current and quick ratio numbers attest to its ability to repay loans and settle its debt on time.
- Investors use the ratios to determine if a company is a worthy investment. An investor can glean insights into how well a company manages its finances and determine the possible ROI from the ratios.
Calculating SaaS quick ratio to track and reduce customer churn
SaaS companies don't use the same formula to calculate quick ratios because their revenue model doesn't follow the conventional model. Subscription companies view assets and liabilities from a different perspective, and it shows in their financial analysis.
The previously highlighted quick ratio formula is relevant to most traditional business niches but is dead in the water in the SaaS sector. That's because the SaaS industry computes variables differently from conventional businesses .
SaaS Quick Ratio = (New MRR + Expansion MRR + Reactivation MRR) ÷ Contraction MRR + Churn MRR)
Let's say, for instance, these are the numbers from your SaaS financial statements.
New MRR: $200,000
Reactivation MRR: $150,000
Expansion MRR: $175,000
Churned MRR: $90,000
Your SaaS Quick Ratio = ($250k + $150k +175k) ÷ $90k = 5.8
From the financial analysis, it's clear that your company is growing steadily. You can easily tell that the company has excellent growth MRR and low churn but calculating the SaaS quick ratio puts things into perspective.
A SaaS quick ratio offers profound insights into your company's performance while letting you know which parts need improvement. If your SaaS quick ratio is:
- < 1: You may not survive the next two months or less
- 1 to 4: Your company has a sluggish growth trajectory, and you'll run into cash flow problems if the growth MRR doesn't improve.
- 4: You have an excellent growth trajectory, and the company is growing efficiently. You're making back four or more times in growth MRR for every dollar you lose or churn.
From the above example, this company's financial health is in the green. It's making back almost $6 for every dollar lost or churned.
Monitor SaaS quick ratio with ProfitWell Metrics
ProfitWell Metrics provides real-time, accurate subscription reporting and analytics in one dashboard. It uses a secure and GDPR-compliant system that integrates seamlessly with various platforms, including Stripe, ReCharge, Braintree, Chargify, and more. ProfitWell pulls data about your business performance and customers into an intuitive dashboard.
With ProfitWell Metrics, you can monitor and break down your MRR into components such as new MRR, upgrades, existing customers, downgrades, and churn. The unparalleled financial reporting provides a high-level view of your business while letting you dig into specifics.
Other metrics include segmentation, customer acquisition, retention, and customer engagement. You can access your SaaS metric from virtually any device through ProfitWell's mobile app or the Metrics API to keep your finger on the pulse.
Current ratio vs quick ratio FAQs
What is the acid test ratio.
Also known as the quick ratio, the acid test ratio is a conservative liquidity ratio that only uses liquid or quick assets. It excludes inventory and prepaid assets to consider assets that can be turned into cash in 90 days or less.
Why is current ratio important?
The current ratio is important because it helps to assess your firm's liquidity position and financial health. It calculates if the company's current assets are enough to cover its short-term obligations.
How can a company improve its current ratio?
A company can improve its current ratio by using long-term financing, paying off liabilities, lowering its overhead, long-term funding, and optimal receivables and payables management. Bolstering sales also help to improve the liquidity ratio.
How to find current ratio on a balance sheet?
The balance sheet doesn't list the current ratio, but it provides all the information you need to calculate your company's current ratio.
To calculate your firm's current ratio, you need to check all the current liabilities and current assets itemized on the balance sheet. You can then use the current ratio formula (total current assets ÷ total current liabilities) to calculate the current ratio.
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How to Calculate Your Quick Ratio
Maddy Osman
Whether it’s paying your vendors or covering payroll , you want to be sure you have enough cash (or other easily convertible assets) on hand to keep your operations running smoothly.
Your ability to cover business expenses using existing assets is known as your company’s liquidity. As a business owner, understanding your liquidity helps you ensure your business stays afloat and grows.
The good news is that you don’t need to be a finance professional to calculate or understand your liquidity. Several ratios can give you an understanding of your business’s liquidity, including the quick ratio.
What is the Quick Ratio?
The quick ratio measures your liquidity by comparing the value of your cash and near-cash assets to your current liabilities. In other words, the quick ratio tells you if you can pay your bills without selling any assets, like inventory , or getting financing.
You may also hear the quick ratio referred to as the acid test ratio after the slang term acid test, which refers to a quick conclusive test that decides the value of something.
Who Uses the Quick Ratio?
Investors often use the quick ratio as part of their financial research to analyze your company’s financial health while considering potential investment opportunities .
A high quick ratio indicates better financial health. In particular, it means that you can cover your operating expenses and other current liabilities without selling inventory and long-term assets or applying for financial assistance. On the other hand, a lower quick ratio indicates that your business may have trouble paying debts.
Additionally, banks and other lending institutions may calculate your quick ratio when deciding whether to give you a loan . Suppliers may also look at your quick ratio to see if you have a good history of paying off operating expenses.
You need to understand the quick ratio if you’re seeking outside capital or negotiating with suppliers. If you can show your ability to cover short-term obligations without selling long-term assets, that’s a financial strength you can leverage during negotiations.
How to Calculate the Quick Ratio
The basic formula for calculating your quick ratio (QR) is as follows:
QR = QA / CL
QA = Quick assets and CL = Current liabilities
Current liabilities , also known as short-term liabilities, refer to all financial obligations due within one year. Examples include operating expenses, accounts payable, dividends, and immediate debt payments.
When calculating quick assets, you can use one of two formulas. Both formulas will give you your quick ratio. We recommend choosing the one where the values are easy for you to access.
QA = CE + MS + AR
CE = Cash equivalents
MS = Marketable securities
AR = Accounts receivable
QA = CA - I - E
CA = Current assets, I = Inventory, and PE = Prepaid expenses
Let’s take a closer look at each one.
Formula Version 1 Explained
The first example calculates your quick ratio with quick assets as cash, cash equivalents, marketable securities, and a portion of your accounts receivable.
QR = (CE + MS + AR*) / CL
Cash equivalents (CE) are assets with a maturity of three months or less, such as treasury bills. Marketable securities (MS) are short-term investment products that usually mature in one year or less, which means you can sell them for cash without losing any value. Examples of these include stocks, bonds, and money market funds.
*For accounts receivable (AR), only consider the dollar amount you expect to receive within the next 90 days.
If you have a large accounts receivable balance and give your customers 180 days to make their payments, including the account’s total value would inflate your quick ratio, which might provide a false sense of security.
Formula 1 Sample Calculation
To better understand how this formula works, consider the following example.
Say you own a carpet cleaning business called Handy Carpet Cleaners, and your company’s balance sheet has the following information:
Quick Assets (QA)
Accounts receivable (AR*) = $130,000* (of which $60,000 can be collected in 90 days)
Marketable securities (MS) = $7,000
Cash + cash equivalents (CE) = $63,000
Current Liabilities (CL)
Accounts payable = $105,000
Accrued expenses = $11,000
Using the first formula, you would calculate your quick ratio as:
QR = ($63,000 + $7,000 + $60,000) / ($105,000 + $11,000)
QR = $130,000 / $116,000
A quick ratio of 1.12 indicates you have enough quick assets to cover your immediate liabilities. Specifically, it means that for every $1.00 of current debt and expenses, you have $1.12 worth of quick assets to cover it.
Formula Version 2 Explained
The second formula starts with your current assets (CA) and subtracts those that aren’t considered quick assets.
In other words, you calculate quick assets by subtracting inventory (I) and prepaid expenses (PE) from your current assets (CA or cash plus assets you can convert into cash within one year).
QR = (CA - I - PE) / CL
For accounting purposes , inventory includes your finished products plus raw materials and components. Inventory is not considered a near-cash asset in the quick ratio because you usually have to drastically reduce the price of your products to sell off inventory in 90 days or less.
Prepaid expenses, such as subscriptions and insurance, are considered current assets. However, they’re excluded from the quick ratio formula because you can’t use them to pay off current liabilities.
Formula 2 Sample Calculation
Let’s take a look at how the second formula works. In this example, imagine your carpet cleaning business has a competitor called Spotless Carpets, and their balance sheet contains the following.
Current Assets (CA)
Current Assets (CA) = $125,000
Inventory (I) = $15,000
Prepaid expenses (PE) = $7,000
Accounts payable = $120,000
Accrued expenses = $10,000
Using the second formula, you would calculate your quick ratio as:
QR = ($125,000 - $15,000 - $7,000) / ($120,000 + $10,000)
QR = $103,000 / $130,000
A quick ratio of 0.79 indicates your competitor does not have enough quick assets to cover immediate liabilities. Rather, for every $1.00 of current debt and expenses, they only have $0.79 of quick assets.
How to Interpret the Quick Ratio
The normal quick ratio value is 1, which means you have exactly enough cash and liquid assets to pay off your expenses and debts due within 12 months.
A value of less than one indicates you may not be able to pay off your current liabilities completely.
On the other hand, having a quick ratio higher than one indicates higher liquidity and means you have more than enough liquid assets to cover your current obligations.
For example, a quick ratio of 1.2 means you have $1.20 worth of liquid assets on hand to cover every $1 of current obligations.
Ideally, a good quick ratio is 1 or slightly higher. If your company’s quick ratio is too high, it shows you can cover expenses, but you’re not reinvesting assets into business growth. For an investor, this means that your business can cover its debts but may not generate a good return.
What Does it Mean if Your Quick Ratio is Too Low?
If your quick ratio is less than one , it means that you might have to sell long-term assets to cover your operating expenses and other current obligations. It may also signal that your current business operations don’t generate enough income to keep the company afloat.
Generally, a ratio of less than one tells investors, lenders, and suppliers to view your business with caution.
However, it’s essential to keep in mind that the quick ratio, while valuable, does not paint a complete picture of your financial situation since it doesn’t take into account your industry or business model.
In particular, businesses that move their stock quickly (such as grocery stores) might have a low quick ratio after subtracting inventory but still be able to pay off short-term liabilities.
To get a comprehensive picture of your company’s financial health, investors look at your cash flows and financial statements along with liquidity ratios. Cash flow and financial statements help them understand how your business generates money and how well you manage cash.
Comparing the Liquidity Ratios
The quick ratio is one of several liquidity ratios used in financial analysis. As the name implies, liquidity ratios measure how well your company can use its assets to pay for liabilities.
The other two most commonly used metrics are the current and cash ratios. Investors, lenders, and potential suppliers may look at all three values when evaluating your business because one approach may be generous and another may be conservative.
Quick Ratio vs. Current Ratio
The current ratio is also a measure of a company’s financial health. It gauges a company’s ability to pay its current, or short-term liabilities, with its current assets.
Compared to the quick ratio, the current ratio is a more generous estimate of liquidity since it factors in all payments your customers owe plus inventory. The quick ratio, however, excludes inventory and less liquid assets.
If you’re in an industry that has reliably quick inventory turnover, such as transportation, technology, or retail, then the current ratio might be a better indicator of liquidity since you can turn your stock into cash in the short-term.
You can calculate it using the following formula:
Current Ratio = CA / CL
CA = Current assets and CL = Current liabilities
Current assets include cash, cash equivalents, accounts receivable, inventory , and other assets you can convert into cash within one year.
A current ratio of 1 indicates that you have enough current assets to cover the expenses and debts owed within the year.
Like the quick ratio, it’s ideal to have a current ratio of 1 or higher, but too high (such as 3 or higher) might indicate that you’re not putting extra income to productive use.
A current ratio of lower than 1 means that your current expenses and debts are greater than your current assets.
Quick Ratio vs. Cash Ratio
The cash ratio estimates your company’s liquidity by measuring the value of your cash and cash equivalents against the value of your current liabilities. Since the cash ratio does not include short-term assets like accounts receivable and inventory, it’s more conservative than the other estimations.
You can calculate your cash ratio using the following formula:
Cash Ratio = CE / CL
CE = Cash and cash equivalents and CL = Current liabilities
A cash ratio higher than 1 means that you have more cash on hand than current liabilities, whereas a ratio lower than 1 means that your short-term financial obligations exceed your cash.
If your cash ratio is equal to 1, you have precisely enough cash and cash equivalents to cover your current liabilities.
Liquidity Ratios Example
To see how the three ratios compare, let’s consider the same example we used before with Handy Carpet Cleaners:
Current Assets (CA)
Inventory (I) = $25,000
Looking at just the cash ratio, you might think that your business would be in trouble since you only have $0.54 in cash for every $1.00 of current liabilities.
However, a quick ratio of 1.12 indicates that you’ll be able to cover current expenses and debts by liquidating marketable securities and collecting your receivables.
The current ratio paints an even more optimistic picture of your company’s financial health. A current ratio of 1.94 suggests that once all customer payments and inventory are taken into account, you can cover current liabilities and still have assets left.
By calculating and comparing all three financial ratios , you’ll have a better understanding of your company’s short-term liquidity and understand how much of a role your sales and inventory play in paying for operating expenses.
In Short: Understanding Your Quick Ratio
Calculating your quick ratio can give you insight into whether or not your business has enough assets to pay for operating expenses and short-term debt. But if you are in an industry that has quick inventory turnover, consider both the quick and current ratio when measuring liquidity.
For more information on tools that can help you manage your day-to-day operating expenses, discover Hourly’s easy full-service payroll solutions today.
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What Is the Quick Ratio?
Definition and examples of the quick ratio, types of financial ratios, quick ratio vs. current ratio, what it means for individual investors.
- How To Find a Firm's Quick Ratio
seksan Mongkhonkhamsao / Getty Images
The quick ratio is a measure of a company's short-term liquidity and indicates whether a company has sufficient cash on hand to meet its short-term obligations. The higher a company’s quick ratio is, the better able it is to cover current liabilities.
Key Takeaways
- The quick ratio measures short-term liquidity.
- It does not include inventory in the calculation, so it’s more conservative than the current ratio.
- Quick ratio is one of many financial ratios used for evaluating firms.
- Values can be taken from the balance sheet in the company's most recent financial filing to calculate the quick ratio yourself.
The quick ratio provides a simple way of evaluating whether a company can cover its short-term liabilities very quickly. This is important for a business because creditors, suppliers, and trade partners expect to be paid on time.
Investors will use the quick ratio to find out whether a company is in a position to pay its immediate bills.
Because of its focus on assets that are immediately available to meet short-term obligations, the quick ratio is also known as the “acid test ratio.”
The formula for calculating the quick ratio is quick assets/current liabilities. Quick assets are a subset of current assets that can more readily be converted into cash with minimal loss in value. Examples of quick assets include cash, marketable securities, and accounts receivable.
Quick assets can also be thought of as current assets excluding inventory. That’s because sometimes, inventory may be difficult to liquidate quickly enough, or it has an uncertain liquidation value, so it isn’t clear if it can be converted in time—or how much cash it will provide. For that reason, the quick ratio formula is often written as: (current assets - inventory)/current liabilities.
Current liabilities are financial obligations that the firm must pay within a year.
As an example of the quick ratio, let's assume a company has the following current assets:
Now, assume current liabilities are $350,000.
The firm's quick ratio is: ($50,000 + $50,000 + $400,000) / $350,000 = $500,000/$350,000 = 1.43
That means that the firm has $1.43 in quick assets for every $1 in current liabilities. So the company has adequate liquidity to pay its short-term bills. Any time the quick ratio is above 1, then quick assets exceed current liabilities.
If the quick ratio is less than 1, the firm does not have sufficient quick assets to pay for current liabilities.
For example, from the illustration above, assume that the firm's current liabilities are instead $600,000. The quick ratio would be: $500,000/$600,000 = 0.83
The quick ratio is just one ratio used for analyzing the performance or financial position of a company. There are many more financial ratios, and they can be categorized into types based on their function. The main categories of financial ratios are:
- Profitability : These ratios measure the firm's ability to generate a return. Examples include profit margin, return on assets, and return on equity.
- Asset utilization : Asset utilization ratios measure how effective the firm is at selling its inventory, collecting its receivables, and employing its fixed assets.
- Liquidity : These ratios, the quick and current, measure the firm's ability to pay its short-term financial obligations.
- Debt utilization : These assess the firm's debt position relative to its assets and earnings.
The quick ratio and current ratio are very similar. They are both liquidity ratios that assess a firm's ability to meet any financial obligations that will be due within one year.
However, the quick ratio is the more conservative measure of the two because it only includes the most-liquid assets in the calculation. The current ratio measures the firm's near-term liquidity relative to the firm's total current assets, including inventory.
Taking the same information from the example above, we can calculate the firm's current ratio by simply including the inventory: ($50,000 + $50,000 + $400,000 + $450,000)/ $350,000 = 2.7
Because the quick ratio is a measure of how well a company is positioned to meet its financial obligations, it can be an important metric for determining a company’s financial well-being. An illiquid firm that can’t pay its short-term bills may not remain in business.
Individual investors who pick their own stocks instead of buying index funds or actively managed mutual funds may want to consider the quick ratio as part of their analyses.
How To Find a Firm's Quick Ratio
To calculate a firm's quick ratio, you can look at the most recently reported balance sheet from a company to get the quick assets and current liabilities because the purpose of the balance sheet is to list all the firm's assets and liabilities. You can then pull the appropriate values from the balance sheet and plug them into the formula.
Companies will often post their quarterly and annual financial reports, including their balance sheets, on their websites. You also can search for annual and quarterly reports on the Securities and Exchange Commission website.
Carl S. Warren, James M. Reeve, Jonathan E. Duchac. " Financial and Management Accounting ." Page 474. South-Western College Pub, 13th edition (2015). Accessed June 28, 2021.
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6 Financial Ratios for Small Business Owners to Live By
As a small business owner, you work hard to make your company successful. When problems come up, you face them head-on to push your business forward. Whether you go an inch or a mile, you record all your financial moves in your small business online accounting records.
If you simply write down your transactions, you could miss key information about your financial fitness. You need financial ratios to measure your momentum.
Why look at financial ratios for small business?
Financial ratios help make sense of your accounting information. Ratios show you what aspects of your business are efficient (and what’s not working) by comparing figures.
Ratios compare your present conditions to past performance. They help you identify your gains and weaknesses. By looking at trends in your strengths and shortcomings, you can improve business operations.
Financial ratios also compare you to other companies in your industry, so you can see how you stack up against your competitors. Lenders look at ratios when you apply for a loan.
Statements to use
Many ratios come from two financial statements : the balance sheet and the income statement.
- The balance sheet shows your business’s net value. It includes your assets, liabilities, and equity.
- The income statement includes all the money coming in and out of your business. It shows how you use assets and liabilities.
Learn what financial statements can do for your business, how to create them, and more.
Small business financial ratios
Take a look at the following six financial ratios to use in your business.
1. Common size ratio
The common size ratio helps you compare one aspect of your accounting to the big picture of your finances. You calculate each line item as a percentage of the total amount on the statement.
Common Size Ratio = Line Item / Total
Common size ratio for cash is 2.5% because:
$500 cash / $20,000 total = 0.025
0.025 X 100 = 2.5%
You can use the common size ratio with your balance sheet or income statement. For example, you can find the percentage of assets you have on the balance sheet. You can see your business’s percentage of sales made on the income statement.
2. Current ratio
A current ratio shows your present financial strength. It represents how many times bigger your current assets are compared to your current liabilities . This is also called a working capital ratio.
Current Ratio = Total Current Assets to Total Current Liabilities
Current ratio is 2 to 1 because:
$20,000 current assets to $10,000 current liabilities = 2 to 1
A 2 to 1 ratio is healthy for your business. This means you have twice as many assets as liabilities.
3. Quick ratio
A quick ratio shows if you can meet financial obligations, even if something unexpected happens. For example, if you own a floral shop, would you be able to handle unanticipated maintenance costs on your delivery truck?
Quick Ratio = (Total Current Assets – Total Current Inventory) / Total Current Liabilities
Quick ratio is 0.5 because:
($20,000 current assets – $15,000 current inventory ) / $10,000 current liabilities = 0.5
A healthy quick ratio is 1.0 or more.
4. Inventory turnover ratio
An inventory turnover ratio reveals the how frequently you convert inventory into sales. It shows how much product is sold and how efficiently you manage inventory.
Inventory Turnover Ratio = Cost of Goods Sold / Average Inventory
Inventory turnover ratio is 1.16 because:
$1,750 cost of goods sold / $1,500 average inventory = 1.16
The greater the inventory turnover ratio, the more frequently inventory converts into cash. A greater inventory turnover ratio is good for business because it reflects greater sales.
5. Debt-to-worth ratio
The debt-to-worth ratio shows how dependent you are on borrowed finances compared to your own funding. It compares how much you owe to how much you own. What is business net worth and total liabilities for your company? You’ll need to know these figures before calculating your debt-to-worth ratio.
Debt-to-Worth Ratio = Total Liabilities / Net Worth
Debt-to-worth ratio is 1 because:
Note: Net worth = Assets – Liabilities
$10,000 total liabilities / ($20,000 – $10,000 net worth ) = 1
If the debt-to-worth ratio is greater than 1, your business has more capital from lenders than you. If you are trying to get an SBA loan, or any loan for that matter, the bank might see this as a risk.
6. ROI (return on investment)
ROI compares the amount of money an investment brings into your business to how much you paid for the investment. This ratio shows the money you invest and the profit you get back from it.
ROI = (Earnings – Initial Cost of Investment) / Initial Cost of Investment
ROI is 1.67 because:
($20,000 earnings – $7,500 initial investment ) / $7,500 initial investment = 1.67
The higher your ROI, the more your investments turn into income.
Financial ratios for your small business
The numbers in your accounting books tell a story. They show where you’ve been and suggest where you’re headed. Using ratios to compare financial numbers helps your business recognize successes and solve problems.
Do you need an easy way to record your transactions? Make your life easier by trying our small business accounting software to track finances today. We offer free USA-based support.
This article has been updated from its original publication date of February 18, 2016.
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