The quick ratio is a formula and financial metric determining how well a company can pay off its current debts. Accountants and other finance professionals often use this ratio to measure a company’s financial health simply and quickly.
In this guide, we’ll go over:
- Quick Ratio Definition
- Quick Ratio Formula
- What Is a Good Quick Ratio?
- The Quick Ratio vs. The Current Ratio
- Showing Quick Ratio Skills on Your Resume
- Related Accounting and Finance Skills
Quick Ratio Definition
The quick ratio, also called an acid-test ratio, measures a company’s short-term liquidity against its short-term obligations. Essentially, the ratio seeks to figure out if a company has enough liquid assets (cash or things that can easily be converted into cash) to cover its current liabilities and impending debts. A key point to note, though, is this isn’t a test to see how much debt a company has or if it could seek financing to cover any current debts. Rather, the quick ratio just looks at whether a company’s liquid assets outnumber its liabilities.
This ratio is important because it gives a snapshot of a company’s financial health: Is the company using its assets in a way that it’s not accruing more debt than it can handle?
Who Uses the Quick Ratio?
Many business professionals use the quick ratio to check in on their company’s financial status. Using this ratio may be especially important for accountants because they deal directly with the company’s finances. This ratio is especially vital for accountants who create budgets, like certified management accountants.
Additionally, people outside the company may look at a company’s quick ratio to judge if it is a good investment idea or to make financing decisions. For example, investors, lenders, and suppliers may use this ratio when choosing who to do business with.
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Quick Ratio Formula
The formula for finding a company’s quick ratio involves dividing the company’s most liquid assets, or current assets, by the company’s total current liabilities. The formula is:
Quick Ratio = Liquid Assets / Current Liabilities
Components of the Quick Ratio
A company’s liquid assets are assets that are cash or close to cash. This may include cash and savings, marketable securities (stocks and bonds), and accounts receivable (money owed to the company by customers and clients).
The quick ratio typically excludes prepaid expenses and inventory from liquid assets. Prepaid expenses aren’t included because the cash can’t be used to pay off other liabilities. On the other hand, inventory is often considered a fairly liquid asset. However, inventory can take a long time to convert to cash. Because this ratio seeks to tell how well a company can pay off immediate or pressing debts, inventory isn’t a reliable source.
Learn more about what assets are.
A company’s current liabilities are any immediate debts the company owes. This includes accounts payable (money owed by the company to other businesses or clients), employee wages, taxes, and payments toward long-term debts (like mortgages or loans).
When calculating a company’s current liabilities, there are two options. Some may choose to lump together all debts the company has, regardless of when payments are due. Others may only consider liabilities due within the near future, typically the following six to 12 months.
The benefit of lumping all debts together is it’s more accessible because people outside of the company may not have access to details like when a payment is due. On the other hand, counting only very immediate debts is ultimately more accurate but can be time-consuming and less applicable over a fiscal quarter or year.
How to Calculate the Quick Ratio: Example
Using Apple’s balance sheet for 2022, we can find the following information:
- Cash and cash equivalents: $23,646 million
- Marketable securities: $24,658 million
- Accounts receivable: $28,184 million
- Inventories: $4,946 million
- Other current assets: $53,971 million
- Accounts payable: $64,115 million
- Term debt: $11,128 million
- Other current liabilities: $78,739 million
So, we need to determine Apple’s liquid assets, which are current assets excluding inventory or prepaid expenses. For the fiscal year of 2022, Apple’s liquid assets equal $130,459 million. Apple’s current liabilities total $153,982 million. So our formula would be:
Quick Ratio = $130,459m (liquid assets) / $153,982m (current liabilities)
Based on this formula, Apple’s quick ratio for 2022 is: 0.85
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What Is a Good Quick Ratio?
A quick ratio will be shown as either X:X or a decimal. Using the example from above, the quick ratio for Apple in 2022 can be expressed as a ratio instead of a decimal, though it may be harder to understand. For example, Apple’s 0.85 ratio could be written as 85:100 or, in a simplified form, 17:20.
But what does that decimal or ratio actually mean? Generally speaking, a good quick ratio is anything above 1 or 1:1. A ratio of 1:1 would mean the company has the same amount of liquid assets as current liabilities. A higher ratio indicates the company could pay off current liabilities several times over. For example, a ratio of 5 or 5:1 would mean the company has enough liquid assets to pay off its debts five times.
However, a quick ratio of less than 1 or 1:1 isn’t always a death sentence for a company. It simply means the company does not have enough liquid assets to pay off short-term debts. A company may have excellent terms with its lenders, so those short-term debt payments may be smaller than they seem on the balance sheet. Additionally, for a company like Apple, inventory may be liquid enough to fill in the gaps left by other current assets. Companies can also seek further financing to meet short-term obligations.
A very high quick ratio isn’t always a great idea, either. A high ratio may indicate that the company is sitting on a large surplus of cash that could be better utilized. For example, the company could invest that money or use it to explore new markets.
The Quick Ratio vs. The Current Ratio
There are two main ratios used to measure a company’s financial health: the quick ratio and the current ratio. Both work by comparing a company’s assets to liabilities.
However, the current ratio includes inventory and prepaid expenses in assets because assets are defined as anything that could be liquified within a year for the current ratio. The quick ratio, instead, focuses on very short-term, highly liquid assets, keeping inventory and prepaid expenses out.
Each ratio is ultimately evaluated slightly differently, too. For example, the current ratio is great at giving high ratio scores for companies with large inventories. On the other hand, the quick ratio leans more conservatively, especially for inventory-reliant business models.
There isn’t a single ratio that can determine a company’s health. Ideally, accountants and finance professionals should use multiple metrics to understand a company’s status.
>>LEARN MORE: What Is the Current Ratio?
Showing Quick Ratio Skills on Your Resume
The quick ratio is only one way to measure a company’s financial health. If you have prior work or internship experience with this ratio, there are two spaces on your resume you can discuss it:
- Use the description space to mention experiences that involved quantifying a company’s financial health
- List the quick ratio in your skills section as part of a broader skill, like analyzing financial statements or knowledge of key business performance metrics
If you don’t have any internship or work experience that involved using the quick ratio, you can discuss any coursework or personal experiences with this calculation. For example, you can mention if you helped a family member’s or friend’s small business figure out their financial health.
Additionally, you could talk about a class project that involved comparing several companies using key financial metrics like the quick ratio, current ratio, and profit margins.
>>MORE: Find out what accounting skills you need on your resume.
Related Accounting and Finance Skills
Understanding how to calculate and use a quick ratio is a vital skill for accountants and many other finance professionals. Some other essential skills for a career in finance or accounting include:
- Knowing how to calculate and use EBITDA
- Knowledge of important business concepts, like revenue
- Data modeling
- Analytical skills
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