What is Quick Ratio?

The quick ratio measures a company’s short-term financial strength by comparing its liquid assets with current liabilities. It shows whether a business can meet near-term obligations without selling inventory. Analysts often review this ratio to judge immediate liquidity. A higher value usually signals better short-term payment capacity, while a lower value may indicate tighter cash conditions. This article explains what is quick ratio and how to calculate it. 

Calculation of Quick Ratio

After understanding the quick ratio meaning, let's understand how to calculate it. 

Formula 

Quick Ratio = (Current Assets − Inventory − Prepaid Expenses) ÷ Current Liabilities 

Example: Assume a company reports: 

• Cash and equivalents: ₹5,00,000 
• Marketable securities: ₹2,00,000 
• Accounts receivable: ₹3,00,000 
• Inventory: ₹4,00,000 
• Current liabilities: ₹5,00,000 

Step-by-step calculation: 

1. Add liquid assets (excluding inventory): 
   ₹5,00,000 + ₹2,00,000 + ₹3,00,000 = ₹10,00,000 
2. Divide by current liabilities: 
   ₹10,00,000 ÷ ₹5,00,000 = 2.0 

This means the company has twice the liquid assets needed to cover short-term obligations. 

Components of Quick Ratio

The following are components of the quick ratio: 

1. Cash and Cash Equivalents: Cash and cash equivalents include physical cash, bank balances, and highly liquid deposits that can be accessed quickly for payments. 
2. Marketable Securities: Marketable securities are short-term investments that one can sell easily in the market with little to no change in their value. 
3. Accounts Receivable: Accounts receivable represent amounts expected from customers within a short period and are generally considered liquid. 
4. Current Liabilities: Current liabilities represent obligations due within twelve months. This figure acts as the denominator when calculating the quick ratio. 

Importance of Quick Ratio

Here is why the quick ratio is important: 

• It indicates the company’s ability to meet short-term obligations without depending on inventory sales. 
• It assists lenders and investors in assessing the immediate liquidity position. 
• It supports comparison between companies operating in the same sector. 
• It highlights potential cash flow stress at an early stage. 
• It complements other measures like the current ratio for broader analysis. 

Limitations of Quick Ratio

While the quick ratio offers various benefits, it does include a few limitations, such as: 

• Ignores the timing of receivables collection, which may affect actual liquidity. 
• Does not consider cash flow patterns within the accounting period. 
• It may present a misleading picture for businesses with fast inventory turnover. 
• Relies heavily on balance sheet figures that reflect a single date. 
• Cannot replace comprehensive financial analysis. 

Conclusion 

The quick ratio provides a focused view of a company’s short-term liquidity by excluding inventory from current assets. It allows analysts to assess whether immediate obligations can be met using highly liquid resources. When reviewing companies on a share trading app, investors often check the quick ratio to better understand the company’s short-term financial position before making decisions.