what the quick ratio can tell you
the quick ratio measures the dollar amount of liquid assets available against the dollar amount of current liabilities of a company liquid assets are those current assets that can be quickly converted into cash with minimal impact on the price received in the open market while current liabilities are a company s debts or obligations that are due to be paid to creditors within one year a company that has a quick ratio of less than one may not be able to fully pay off its current liabilities in the short term while a company having a quick ratio higher than one can instantly get rid of its current liabilities for instance a quick ratio of 1 5 indicates that a company has 1 50 of liquid assets available to cover each 1 of its current liabilities while such numbers based ratios offer insight into the viability and certain aspects of a business they may not provide a complete picture of the overall health of the business it is important to look at other associated measures to assess the true picture of a company s financial health the higher the quick ratio the better a company s liquidity and financial health but it is important to look at other related measures to assess the whole picture of a company s financial health components of the quick ratiocash is among the more straightforward pieces of the quick ratio a company should strive to reconcile its cash balance to monthly bank statements received from its financial institutions this cash component may include cash from foreign countries translated to a single denomination cash equivalents are often an extension of cash as this account often houses investments with very low risk and high liquidity cash equivalents often include but may not necessarily be limited to treasury bills certificates of deposits being mindful of options fees to break the cd bankers acceptances corporate commercial paper or other money market instruments in a publication by the american institute of certified public accountants aicpa digital assets such as cryptocurrency or digital tokens may not be reported as cash or cash equivalents 1marketable securities are usually free from such time bound dependencies however to maintain precision in the calculation one should consider only the amount to be actually received in 90 days or less under normal terms early liquidation or premature withdrawal of assets like interest bearing securities may lead to penalties or discounted book value whether accounts receivable is a source of quick ready cash remains a debatable topic and it depends on the credit terms that the company extends to its customers a company that needs advance payments or allows only 30 days for customers to pay will be in a better liquidity position than a company that gives 90 days on the other hand a company could negotiate rapid receipt of payments from its customers and secure longer terms of payment from its suppliers which would keep liabilities on the books longer by converting accounts receivable to cash faster it may have a healthier quick ratio and be fully equipped to pay off its current liabilities the total accounts receivable balance should be reduced by the estimated amount of uncollectible receivables as the quick ratio only wants to reflect the cash that could be on hand the formula should not include any receivables that a company does not expect to receive the quick ratio pulls all current liabilities from a company s balance sheet as it does not attempt to distinguish between when payments may be due the quick ratio assumes that all current liabilities have a near term due date total current liabilities are often calculated as the sum of various accounts including accounts payable wages payable current portions of long term debt and taxes payable because prepaid expenses may not be refundable and inventory may be difficult to quickly convert to cash without severe product discounts both are excluded from the asset portion of the quick ratio the difference between the quick ratio and the current ratiothe quick ratio is more conservative than the current ratio because it excludes inventory and other current assets which are generally more difficult to turn into cash the quick ratio considers only assets that can be converted to cash in a short period of time the current ratio on the other hand considers inventory and prepaid expense assets in most companies inventory takes time to liquidate although a few rare companies can turn their inventory fast enough to consider it a quick asset prepaid expenses though an asset cannot be used to pay for current liabilities so they re omitted from the quick ratio advantages and disadvantages of the quick ratiothe quick ratio has the advantage of being a more conservative estimate of how liquid a company is compared to other calculations that include potentially illiquid assets the quick ratio is often a better true indicator of short term cash capabilities the quick ratio is also fairly easy and straightforward to calculate it s relatively easy to understand especially when comparing a company s liquidity against a target calculation such as 1 0 the quick ratio can be used to analyze a single company over a period of time or can be used to compare similar companies there are several downsides to the quick ratio the financial metric does not give any indication of a company s future cash flow activity though a company may be sitting on 1 million today the company may not be selling a profitable product and may struggle to maintain its cash balance in the future there are also considerations to make regarding the true liquidity of accounts receivable as well as marketable securities in some situations conservative approach to estimating a company s liquidityrelatively straightforward to calculateall components are reported on a company s balance sheetcan be used to compare companies across time periods or sectors