The quick ratio, also known as the acid-test ratio, calculates a company’s ability to cover its current liabilities by means of its current assets. It is a liquidity ratio used by a company’s stakeholders, investors, and lenders and takes a company’s quick assets—which are current assets minus inventory and long-term receivables—and divides them by current liabilities. We’ve provided a calculator to help you determine your quick ratio and learn more about the financial standing of your business.
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How to Calculate the Quick Ratio
The quick ratio formula is:
| Quick Ratio | = | Current Assets |
| Current Liabilities |
Current Assets
Current assets (also known as liquid assets) are items on your balance sheet that can quickly be converted into cash. In determining the quick ratio, this includes assets that can be liquidated generally within 90 days or less. Examples of current assets include:
- Cash: Cash consists of funds held in checking, savings, any coins or currency, petty cash, and any money orders and bank drafts.
- Cash equivalents: Cash equivalents include short-term investments, such as treasury bills, money market funds, government bonds, commercial paper, and any other marketable securities that can be liquidated easily.
- Accounts receivable (A/R): This includes a company’s outstanding invoices, as well as money the company has yet to collect from customers, in exchange for delivered goods or services. These are typically due within 90 days, making them highly convertible to cash.
- Marketable securities: These involve financial assets that can be traded within public markets and can be sold off quickly.
Our related resources:
- What Are Assets in Accounting: Types & Examples
- What Are Accounts Receivables & the A/R Journal Entries
- Cash vs Petty Cash: Usage & Purpose
What’s Excluded From Current Assets
Any assets that can’t quickly be converted to cash—in this case within 90 days—are excluded from current assets and, therefore, excluded from a company’s quick ratio. Some examples are:
- Property: Any buildings, land, or other real property held by a business aren’t factored in the quick ratio.
- Inventory: This is excluded as it’ll be difficult to sell inventory off within 90 days without discounting and potentially selling at a loss.
- Equipment: Any machinery, technology, such as computers and servers, and other equipment not considered a part of the company’s inventory is excluded.
- Vehicles: Cars, trucks, or other titled vehicles owned by a company and not considered a part of its inventory.
Current Liabilities
Current liabilities for a quick ratio calculation include all short-term financial obligations that are due within 90 days. Some examples of current liabilities are:
- Accounts payable (A/P): A/P are any obligations to pay off short-term debt to creditors, vendors, and suppliers.
- Accrued liabilities: These are business expenses that have accrued but not yet been billed for.
- Taxes: Taxes include sales tax, income tax, and payroll tax.
- Payroll: Payroll includes any salaries, wages, bonuses, and commissions owed to employees.
- Loans: Examples of loans include any short-term loans or long-term debts with maturities within one year.
Our related resources:
- What Are Current Liabilities? How to Calculate Them [+ Calculator]
- What Are Accounts Payable & How to Account for Them
- Accrued Expenses vs Accounts Payable
- What Is Payroll?
What’s Excluded From Current Liabilities
Any long-term financial obligations that aren’t payable within one year are excluded from current liabilities. This includes:
- Debt, such as commercial real estate (CRE) loans
- Small Business Administration (SBA) loans
- Most business debt consolidation loans
Quick Ratio Example
As a simple example, let’s say a business has the following current assets available:
Current Assets | Asset Value |
|---|---|
Cash & cash equivalents | $60,000 |
Accounts receivable | $10,000 |
Marketable securities | $5,000 |
Total current assets | $75,000 |
Now let’s determine the current liabilities of the business:
Current Liabilities | Asset Value |
|---|---|
Short term loans | $25,000 |
Accounts payable | $10,000 |
Accrued liabilities | $5,000 |
Total current liabilities | $40,000 |
In this example, we’ve added a business’s total current assets in one table and totaled the current liabilities in another. Once we’ve determined both values, we can use them to divide the assets by the liabilities to calculate the quick ratio.
$75,000 (current assets) ÷ $40,000 (current liabilities) = 1.9 (Quick ratio)
In this instance, a quick ratio of 1.9 would indicate that a company has $1.90 of current assets available to cover each $1 of its current liabilities.
Why the Quick Ratio Matters
The quick ratio can be used as a tool to measure the financial well-being of a company. While other calculations should be taken into account to provide a thorough overview, the quick ratio in particular can help paint a picture of a company’s ability to meet short-term obligations.
It can be used by investors, lenders, and company stakeholders to make various financial decisions regarding a business, whether it be to extend credit or invest capital. Small businesses can also benefit from using the quick ratio, as well as other liquidity ratios, to assess financial health.
Pros & Cons of the Quick Ratio
| PROS | CONS |
|---|---|
| Offers an overview of the financial health of a business with a quick calculation | May overestimate ability to collect receivables quickly, which affects ability to pay liabilities |
| Allows a company to easily determine if it can invest additional assets | Can be a limited financial snapshot, which doesn’t consider future cash flow |
| Can help a company determine if improved receivable collection or short-term debt payment is needed | Doesn’t consider the effects of long-term debts on the bottom line by only considering current liabilities |
What Is a Good Quick Ratio?
In general, the higher the quick ratio is, the higher the likelihood that a company will be able to cover its short-term liabilities. For many industries, the ideal quick ratio falls anywhere from 1.2 to 2.0.
- Anything below 1.0 indicates a company will have difficulty meeting, or be unable to meet, its current liabilities without increasing sales, selling off fixed assets or inventory, or raising capital.
- A ratio of 1.0 or greater demonstrates that a company has sufficient current assets to meet current liabilities.
- Anything over 2.0 may indicate that a company isn’t investing its current assets aggressively.
Additionally, the quick ratio of a company is subject to constant adjustments, as current assets (such as cash-on-hand) and current liabilities (like short-term debt and payroll) will vary. As a result, many companies try to keep their quick ratio within a certain range rather than pegged at a particular number.
How to Improve the Quick Ratio
A company with a higher quick ratio is considered to be more financially stable than those with a lower quick ratio. Having a healthy quick ratio is important for companies and their creditors, lenders, investors, and other stakeholders. Businesses should always work to keep their quick ratio managed properly.
Three of the most common ways to improve the quick ratio are to:
Increasing sales will subsequently increase the turnover of inventory. Since inventory is excluded from quick ratio calculations, selling your inventory would yield more cash, which is included in the quick ratio.
Reducing the collection period of A/R has a positive impact on a company’s quick ratio. A shorter collection period can help boost a company’s incoming cash flow and will also reduce the odds of encountering long-term debtors and bad debts. Setting clear invoice terms at the beginning of any transaction and making an active collection effort will also help.
Our related resources:
- Common Invoice Payment Terms & Tips on Setting Them
- How to Make Collection Calls (Script + Tips)
Managing your company’s liabilities is essential. Current liabilities are in the denominator of the quick ratio, and keeping them low will put your business in a better position. This can be achieved by paying off creditors faster whenever possible and reducing the repayment terms for business loans.
Liquidity Ratios Alternatives
Liquidity ratios are various calculations that examine a company’s ability to cover short-term obligations. In addition to their use by company stakeholders to measure the financial health of a business, they can be used by investors and creditors when determining whether a company meets small business loan requirements. Besides the quick ratio, the current ratio and cash ratio are also used.
Current Ratio
The current ratio, sometimes known as the working capital ratio, is a popular alternative to the quick ratio. The two ratios differ primarily in the definition of current assets. Current assets are typically any assets that can be converted to cash within one year, which is how the current ratio is defined.
Meanwhile, the quick ratio only counts as current assets that can be converted to cash in about 90 days and specifically excludes inventory. A common criticism of the current ratio is that it may underestimate the difficulty of converting inventory to cash without selling the inventory below market price, and potentially at a loss.
Cash Ratio
The cash ratio also compares a company’s current assets to current liabilities. It’s considered the most conservative of like ratios as it excludes both inventory and A/R from current assets. It is based on the assumption that both inventory and A/R may be difficult to collect on and shouldn’t be counted among liquid assets, as to do so may inflate a company’s ability to meet its debt obligations artificially in the short term.
Sometimes, it’s criticized due to its conservative measurement of stability and because it doesn’t account for businesses that are efficient at selling through inventory and collecting on A/R.
Frequently Asked Questions (FAQs)
The quick ratio is a calculation that helps evaluate the relationship between a company’s assets that can be quickly liquidated and its current liabilities. Simply put, the equation for the quick ratio is to divide current assets by current liabilities.
Generally, the higher the quick ratio, the better the financial health of your company. However, if your quick ratio is too high, you may not be properly investing your current assets aggressively. Generally, you want to keep your quick ratio above 1.0. Most companies will try to keep their quick ratio anywhere from 1.2 to 2.0.
The difference between the current ratio and the quick ratio is that the current ratio includes assets that might be difficult to liquidate quickly, usually within the timeline of one year, such as accounts receivable and inventory. The quick ratio only includes assets that can be quickly liquidated or received, typically within 90 days.
Bottom Line
The quick ratio can be used as a simple valuation tool to measure the short-term financial health of a business. Based on the company’s current assets and liabilities, it determines whether or not the company can cover its short-term financial obligations. Keep in mind, it only provides a snapshot of the overall financial capacity of a business, and should be used among other liquidity ratios.
This is especially important if you are considering getting a small business loan for your company, as lenders will use the quick ratio to help determine your company’s ability to repay the debt. Therefore, it’s important to monitor your quick ratio and ensure that your finances are under control.
