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Quick ratio (acid-test ratio)

The quick ratio divides current assets excluding inventory by current liabilities and shows the ability to pay debts without selling inventory. The quick ratio (acid test) is a stricter liquidity measure than the current ratio.
Contents
  1. 1.Key points
  2. 2.Formula / calculation
  3. 3.Interpretation
  4. 4.Pitfalls
  5. 5.Frequently asked questions

Key points

  • Because inventory can take time to sell and lose value, it only counts cash, securities and receivables against short-term debt.
  • A value of 1 or more is usually considered adequate; below 1 means the company depends on selling inventory or new borrowing to pay its debts.
  • the collectability of receivables must be questioned; doubtful receivables inflate the ratio.

Formula / calculation

Quick ratio = (Current assets − Inventory) / Current liabilities. The cash ratio is stricter still: Cash and cash equivalents / Current liabilities.

Interpretation

A value of 1 or more is usually considered adequate; below 1 means the company depends on selling inventory or new borrowing to pay its debts. A wide gap between current and quick ratios points to a heavy inventory burden.

Pitfalls

the collectability of receivables must be questioned; doubtful receivables inflate the ratio. Normal levels differ by sector. Watch the trend rather than a single quarter.

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Frequently asked questions

The quick ratio divides current assets excluding inventory by current liabilities and shows the ability to pay debts without selling inventory.

Quick ratio = (Current assets − Inventory) / Current liabilities. The cash ratio is stricter still: Cash and cash equivalents / Current liabilities.

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