Understand the Quick Ratio: definition, calculation, interpretation, and significance in assessing liquidity.
The Quick Ratio, also known as the Acid-Test Ratio, is a liquidity ratio that measures a company's ability to pay off its short-term debts using its most liquid assets. It is considered a more stringent measure of a company's liquidity than the current ratio, as it excludes inventory from current assets, which may not be easily convertible to cash.
The formula for the quick ratio is:
Quick Ratio = (Cash + Short-term Investments + Accounts Receivable) / Current Liabilities
The quick ratio measures the proportion of the most liquid assets to current liabilities, providing a more conservative estimate of a company's ability to meet its short-term obligations.
A quick ratio of 1:1 means that a company has exactly enough liquid assets to pay off its current liabilities. A ratio higher than 1 indicates that the company has more liquid assets than liabilities, while a ratio lower than 1 suggests that the company may have trouble meeting its short-term obligations. A good quick ratio varies depending on the industry, but a general rule of thumb is to aim for a ratio of 1 or higher