Quick Ratio

How is it calculated?

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

Goal of the Ratio

The goal of this ratio is to gauge of the borrower’s ability to cover short term payment obligations using only “quickly” convertible into cash assets.  This ratio is a derivative of the Current Ratio, but it excludes Inventory from the calculation.  The reason for this is that it takes longer to convert inventory into cash than it does to convert assets such as Accounts Receivable into cash.  During a typical operating cycle, the borrower invests cash into inventory, that inventory sits for a period of time until it sells.  Once the inventory is sold, the asset converts into Accounts Receivable, and the asset remains as an Accounts Receivable until the credit terms require the invoice be paid (typically 30-45 days).  Due to the fact inventory must wait to be sold prior to beginning the AR collection, it takes longer for this asset to be converted into cash.  As a result, the Quick Ratio shows a borrower’s ability to meet their obligations using only “quickly” convertible into cash assets.  

When is it used?

This ratio is typically used in situations where a borrower has a high amount of inventory such as:

•  Retail Store
•  Wholesaler
•  Manufacturer

Rules of Thumb

Higher is better - A higher ratio means it will be even easier for the borrower to meet their obligations.

Please note all ratios should be viewed in relation to industry norms to determine overall adequacy.

What changes in the ratio could mean:

Some example reasons why Quick Ratio can change:

1. Reduction in Days Inventory on Hand
2. Increase in Days Inventory on Hand
3. Profitable Net Income
4. Unprofitable Net Income
5. Ownership Contributions
6. Ownership Distributions
7. Sale of Fixed Assets
8. Purchase of Fixed Assets
9. Additional Principal Reduction on LT Debt
10. WC Injection through new borrowings 

Other Relevant Terms

• Capital
• Balance Sheet
• Working Capital
• Liquidity
• Return to Terminology Library