What the quick ratio tells you
The quick ratio, also called the acid-test ratio, counts only the current assets a business can usually turn into cash at short notice. Cash and cash equivalents are already available. Short-term investments are securities that can be sold quickly. Accounts receivable are invoices customers have not yet paid, which normally come in within the agreed credit terms. Current liabilities are everything due within the year.
Inventory and prepaid expenses are left out. Inventory has to be sold, and often paid for by the customer, before it becomes cash. Prepaid expenses, such as insurance paid in advance, will be used up rather than turned into cash. A result of 0.80 means quick assets cover 80% of current liabilities. The rest would have to come from selling inventory, from future sales or from new borrowing.
Two ways to calculate it
Two definitions are in common use, and the calculator offers both.
- Cash, short-term investments and receivables adds up the most liquid assets directly.
- Current assets minus inventory starts from total current assets and removes inventory only. Prepaid expenses and any other current assets stay in.
The two methods agree only when current assets consist of nothing but cash, short-term investments, receivables and inventory. If the balance sheet also shows prepaid expenses or other items, such as assets held for sale, the subtraction method includes them and gives a higher result. Use the method that matches the figures you want to compare with, and say which one you used.
Reading a high or low result
Because it leaves inventory out, the quick ratio is normally lower than the current ratio for the same balance sheet. The size of the gap shows how much of the current assets is tied up in inventory and, with the first method, prepaid expenses.
- A low ratio can mean the business depends on selling inventory, or on new cash coming in, to meet the obligations due within the year. That may matter less where inventory sells quickly and predictably, and more where it sells slowly.
- A high ratio means more of the year’s obligations are covered without relying on inventory. It can also point to receivables building up because customers pay slowly, or to cash that is not being put to work.
What is normal varies with the industry and the business model. Compare the ratio with the same business in earlier periods, or with similar businesses that use the same method.
What the ratio does not show
- It assumes receivables will be collected. An invoice that is months overdue counts the same as one due next week.
- It is a snapshot of one balance sheet date, so a seasonal business can show very different figures at different points in the year.
- It ignores the timing of payments within the year and the cash that operations will bring in. It also leaves out any unused credit facilities the business could draw on.
Common mistakes
- Comparing a result from one method with a result from the other. The subtraction method gives the higher figure whenever the balance sheet has prepaid expenses or other current assets.
- Counting restricted cash, for example cash held as security for a loan, which cannot be used to pay current bills.
- Using receivables before the allowance for doubtful accounts. Use the net figure shown on the balance sheet.
- Taking the assets and the liabilities from different balance sheet dates.
Related measures
The current ratio counts all current assets, inventory included, so it is the broader test. The cash ratio is stricter still: it drops receivables and short-term investments and counts only cash and cash equivalents. Days sales outstanding shows how long receivables take to turn into cash. To see the current and quick ratios side by side, use current ratio vs quick ratio.