Quick Ratio formula is important concept in accounting. Liquid assets are readily convertible into cash at short notice with little or no risk of loss. Conversion of one assets into cash form for readily use. Conversion of inventory into cash is to take more time and hence it is not liquid assets. Example – cash in hand, cash at bank, marketable securities, debtors, bills receivables. This Quick ratio formula is used to assess the firm’s short term liquidity. The relationship of liquid assets to current liabilities is known as liquid ratio. It is also called as Acid Test ratio. You can easily calculate from below formula
Quick Ratio Formula
Liquid Ratio = (Liquid Assets/Current Liabilities)
Liquid assets mean current assets less stock and prepaid expenses. Current liabilities mean creditors, bills payable (accounts payable) outstanding expenses.
Quick Ratio Importance and advantages
This ratio measures the ability of a company to use its liquid cash or quick assets to extinguish or pay off its current liabilities immediately. The acid test ratio is far more than the working capital ratio, primarily because the working capital ratio allows for the inclusion of inventory assets. It reflects the ability to meet immediate liabilities of the business firm shortly.
The ideal ratio is 1:1. It may differ be industry wise. Business firms with ratios of less than 1 means cannot pay their current liabilities and should be looked at with extreme caution. Moreover, if the acid-test ratio is lower than the working capital ratio, it means current assets are consisting more on inventory. Retail stores are examples of this type of business. It is an indicator that determines whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory. A company can improve its liquidity ratios by raising the value of its current assets, reducing current liabilities by paying off debt, or negotiating delayed payments to creditors. The acid test ratio is more traditional than the current ratio, a better-known liquidity measure, because it excludes stock value from current assets. Stock is excluded because business firm have difficulty convert stock into cash.
It does not considers and taken into stock or inventory. It is less importance than current ratio. It describes only cash position and not entire activity.
From the following quick ratio example you can understand better
Liquid Ratio = Liquid Assets/Current Liabilities
Liquid Assets = Current Assets – (Stock + Prepaid expenses)
= 1,32,500 – (30,500 + 2,000)
= 1,32,500 – 32,500
= $ 1,00,000
Liquid Ratio = 1,00,000/ 75,000
= 1.3 : 1
[Note: another route for current liabilities, to take without bank overdraft also]
Originally posted 2015-01-26 19:00:34.