Another financial ratio that is commonly used to understand how liquid a company is is the quick ratio or as it’s often called the acid test ratio.
The difference between the current ratio and the quick ratio is that the quick ratio only includes cash, marketable securities (which are easily convertible into cash) and accounts receivable. As explained above, it therefore excludes the stock or inventory.
Quick Ratio Formula
Therefore, in order to get the quick ratio, you will need to use the following formula:
You can also use the following formula provided that the current assets only include the current assets as per the equation above plus stock:
Quick Ratio (or Acid Test Ratio)= (Current Assets-Stock)/Current Liabilities
Quick Ratio Example
Let’s say for example, that company A has the following :
- Cash : $500,000
- Accounts Receivable :$1,500,000
- Current Liabilities: $1,000,000
Therefore, the quick ratio is : (1,500,000+ 500,000)/1,000,000= 2
Quick Ratio (Acid Ratio) Analysis
The quick ratio assesses whether a company will be able to cover its current liabilities from its current assets as they are falling due. Therefore, if you want to analyze the quick ratio, the following apply:
If the quick ratio is higher than 1 (ideally as high as possible), the company appears to be able to repay its current liabilities as they are falling due.
If the quick ratio is lower than 1, then the company might be unable to repay some of its current liabilities and the company might face liquidity squeeze.
Quick Ratio (Acid Ratio Test) Calculator
The calculator below will help you find the quick ratio by taking the current assets less the inventory and dividing it by the current liabilities. To be more precise and as explained above, the quick ratio only includes cash, marketable securities and accounts receivable. However, most companies only have the above assets plus stock. Therefore, by taking the total current assets and deducting the stock, we get the same figure.