Quick Ratio

Quick ratio is also called as Acid test ratio. One way to reduce the concern over the composition of the current accounts when computing the current ratio is to use the quick ratio or acid test ratio. The quick ratio is a stricter test of a company's ability to pay its current debts with highly liquid current assets. The quick ratio removes inventories and prepaid assets from the current assets amount used in the calculation of the current ratio. These current assets are considered as least liquid.

The quick ratio formula as follows:

Quick Asset ratio is equal to quick assets divided by current or short-term liabilities (Quick asset ratio= quick assets / short-term or current liabilities).

Let us take an Example of the John Company and Peter Company. The Current Assets and Current Liabilities sections of balance sheet for John Company and Peter Company are given below:

Quick Ratio = Quick Assets/ Current liabilities.

The quick ratio measures the “instant” debt-paying ability of a company, using quick assets. Quick assets are cash receivable and other current assets which can quickly be converted into cash. This often considered desirable to have a quick ratio exceeding 1.0. A ratio less than 1.0 would indicate that the current liabilities cannot be converted by cash and “near cash” assets.

The quick ratio for John And Peter Company is as follows:

John Company: 147,000 dollars +84,000 dollars / 220,000 dollars = 1.05

Peter Company: 120,000 dollars +472,000 dollars / 740,000 dollars = 0.80

As we can see that , John Co. has quick assets in excess of current liabilities, or quick ratio of 1.05. The ratio exceeds 1.0, indicating that the quick assets should be sufficient to meet current liabilities. Peter Co., however has a quick ratio of 0.8. Its quick assets will not be sufficient to cove current liabilities.

Questionnaire:

• What is Quick Ratio?
• How to Calculate Quick ratio? Give an example.