What Is Quick Ratio?

The quick ratio, also known as the quick asset ratio, is a liquidity measure that assesses a company’s ability to meet their short-term financial obligations. It’s calculated by taking a company’s current assets (assets that can be turned into cash within a year) and subtracting its current liabilities (debts that must be paid within a year) and then dividing the resulting number by the company’s current liabilities. The higher the ratio, the better the company’s liquidity and ability to pay its short-term debts. A ratio higher than 1 indicates that the company has adequate short-term resources to cover its obligations.

How to Calculate Quick Ratio

The quick ratio formula is:

Quick Ratio = (Current Assets – Inventory) / Current Liabilities

For example, if a company has $800 in current assets and $400 in inventory, and its current liabilities are $300, its quick ratio would be:

Quick Ratio = ($800 – $400) / $300 = 2

The quick ratio of 2 indicates that the company has $2 in current assets available for every $1 in current liabilities.

Why Is the Quick Ratio Important?

Knowing a company’s quick ratio is important for investors because it provides an insight into the company’s short-term financing needs and liquidity to pay its debts. Investors tend to prefer companies with high quick ratios, as it indicates that the company has enough current assets to cover its current liabilities without relying on outside financing.

The quick ratio is useful for college students, too, since it provides a more accurate picture of a company’s liquidity compared to the current ratio. The current ratio looks at a company’s total assets and liabilities without taking into account inventories and other assets that may not be easily converted into cash. The quick ratio, on the other hand, takes those assets and liabilities into account and is thus a more accurate measure of liquidity.