Quick ratio

What it means

The quick ratio is current assets excluding inventory divided by current liabilities. It shows whether a company can pay its short-term debts from cash and receivables without having to sell stock. It is also known as the acid-test ratio or second-degree liquidity.

It is stricter than the current ratio, which includes inventory in the numerator, and less strict than the cash ratio, which counts only cash. Inventory is excluded because converting it into cash takes longest and its value in a quick sale is uncertain.

A value of around 1 is considered safe, meaning liquid assets cover current liabilities. The right level depends on the industry, though: a retailer with fast stock turnover can operate with less, while a company with long customer payment terms needs more.

How it works in practice

The calculation comes from the balance sheet: inventory is subtracted from current assets and the result divided by current liabilities, including short-term loans. The ratio is tracked over time and against similar companies, not just as a single figure at the balance sheet date.

Banks and suppliers assessing creditworthiness compare the quick ratio with other liquidity and leverage measures. A sharp fall signals that the company is funding operations at its suppliers' expense or struggling to collect receivables.

It can be improved by collecting receivables faster, refinancing short-term debt with long-term debt or reducing the cash tied up in stock. Managing working capital is therefore a direct lever for strengthening liquidity.

What to watch out for

Receivables in the numerator may not really be liquid. If they include old, disputed or uncollectable items, the ratio is overstated. Analysis should therefore look at the ageing of receivables and the allowances made.

The ratio is a snapshot tied to a single day. A company can dress it up at year end, for example by postponing purchases or temporarily repaying a loan. Monthly values and a cash flow plan give a more reliable picture.