How to Calculate the Quick Ratio Formula

The quick ratio is a financial liquidity measure that assesses a company’s immediate ability to cover its short-term financial obligations. This metric focuses on the most readily convertible assets, excluding inventory, which may take longer to sell. It provides insight into a company’s financial health, indicating whether it can meet its immediate debts without having to sell off its stock.

Key Components of the Quick Ratio

To calculate the quick ratio, two main categories of financial elements are required: quick assets and current liabilities. Quick assets represent a company’s most liquid assets that can be converted into cash within a short period, typically 90 days or less. These assets are readily available to satisfy immediate debts.

Cash is the most liquid asset, representing physical currency and funds held in bank accounts. Cash equivalents include highly liquid investments with maturities of three months or less, such as Treasury bills, commercial paper, and money market funds. Marketable securities are short-term investments that can be quickly sold on public exchanges, including stocks or bonds held for a short duration. Accounts receivable are the amounts owed to a company by its customers for goods or services delivered on credit, which are generally expected to be collected within 30 to 60 days.

Current liabilities are a company’s financial obligations due within one year or the operating cycle, whichever is longer. These represent claims that must be settled in the near term. Accounts payable are amounts a company owes to its suppliers for goods or services purchased on credit.

Short-term loans are debts that must be repaid within one year, often used for immediate operational needs. Accrued expenses are costs incurred but not yet paid, such as salaries, utilities, or rent. The current portion of long-term debt refers to the part of a long-term loan that is due for repayment within the next twelve months.

Step-by-Step Calculation

The quick ratio formula is calculated by dividing total quick assets by total current liabilities. The formula can be expressed as: (Cash + Cash Equivalents + Marketable Securities + Accounts Receivable) / Current Liabilities.

The company has cash of $50,000, cash equivalents totaling $20,000, and marketable securities valued at $30,000. Additionally, its accounts receivable amount to $100,000. Summing these figures, the total quick assets are $200,000.

Its accounts payable are $70,000, short-term loans amount to $50,000, and accrued expenses are $30,000. The current portion of its long-term debt is $20,000. These obligations combine to a total current liability of $170,000.

Applying the formula, the quick ratio is calculated by dividing $200,000 (total quick assets) by $170,000 (total current liabilities). This calculation yields a quick ratio of approximately 1.18.

Understanding What the Ratio Tells You

A quick ratio of 1:1 or higher is generally considered acceptable, indicating that a company has at least enough quick assets to cover its current liabilities. A ratio significantly above 1:1 suggests strong liquidity, meaning the company can easily cover its immediate debts without relying on inventory sales. Conversely, a quick ratio below 1:1 may signal potential short-term solvency issues, indicating the company might struggle to meet its immediate obligations without liquidating less liquid assets or securing additional financing.

This ratio offers a more conservative view of liquidity compared to the current ratio because it excludes inventory from current assets. Inventory, while an asset, may not be quickly convertible to cash. Therefore, the quick ratio provides a stricter test of a company’s immediate ability to pay its debts. Analysts often prefer the quick ratio when assessing companies with large inventories, as it removes the potential distortion of unsold goods impacting short-term cash availability.