Quick Ratio (or Acid Test Ratio)

Corporate Finance Institute
11 Apr 201801:35

Summary

TLDRThe quick ratio, also known as the acid test ratio, measures a company's liquidity by comparing current assets minus inventory to current liabilities. Unlike the current ratio, which includes inventory, the quick ratio provides a more conservative view of a company's ability to meet short-term obligations. A rule of thumb suggests a ratio of 1:1, but this may vary by industry and company conditions. Calculating both the current and quick ratios helps analysts assess how much of a company's current assets are tied up in inventory, which can influence decisions regarding liquidity risk.

Takeaways

  • 😀 The quick ratio, or acid test ratio, measures liquidity by excluding inventory from current assets.
  • 😀 It is calculated by taking current assets, subtracting inventory, and dividing by current liabilities.
  • 😀 This ratio is considered a more conservative measure of liquidity compared to the current ratio.
  • 😀 A lower quick ratio is acceptable due to its conservative nature, as it reflects immediate liquidity.
  • 😀 A common rule of thumb for the quick ratio is 1:1, as inventory is excluded, reducing the need for a buffer.
  • 😀 The required quick ratio may vary by industry and the financial state of the company.
  • 😀 It is advisable to calculate both the current ratio and quick ratio for a comprehensive liquidity analysis.
  • 😀 Comparing both ratios helps to assess how much of the current assets are tied up in inventory.
  • 😀 Analysts may determine that having high current assets in inventory is fine if turnover is quick.
  • 😀 Conversely, if inventory turnover is slow, the quick ratio becomes a more critical measure of risk.

Q & A

  • What is the quick ratio, and how is it calculated?

    -The quick ratio, also known as the acid-test ratio, is calculated by taking current assets, deducting inventory, and dividing that by current liabilities.

  • How does the quick ratio differ from the current ratio?

    -The quick ratio is similar to the current ratio but excludes inventory, making it a more conservative measure of liquidity.

  • Why is the quick ratio considered more conservative?

    -It is considered more conservative because it acknowledges that inventory may not be readily converted into cash.

  • What is a generic rule of thumb for the quick ratio?

    -A generic rule of thumb for the quick ratio is 1:1, meaning current assets should at least equal current liabilities.

  • Why is there less of a buffer required in the quick ratio compared to the current ratio?

    -There is less of a buffer required in the quick ratio because inventory is excluded from the calculation, which typically represents a less liquid asset.

  • What factors might justify a higher quick ratio than the generic rule?

    -The appropriate quick ratio may vary based on the industry and the financial state of the company, which might necessitate a higher ratio.

  • What is best practice when evaluating a company's liquidity?

    -Best practice is to calculate both the current ratio and the quick ratio and compare them to assess how much of the current assets are tied up in inventory.

  • How can an analyst use the quick ratio in their assessment?

    -An analyst can determine if a company has a lot of current assets tied up in inventory, which may be acceptable if the company can quickly convert that inventory into cash.

  • What could indicate a risky financial situation regarding the quick ratio?

    -If the quick ratio is significantly lower than the industry average, it may indicate a risky financial situation, suggesting that the company may struggle to meet its short-term obligations.

  • In what scenario might a high level of inventory be acceptable?

    -A high level of inventory might be acceptable if the company has a strong turnover rate, meaning it can quickly sell and replenish its inventory without affecting liquidity.

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Ähnliche Tags
Quick RatioLiquidity MeasureFinancial AnalysisConservative MetricCurrent AssetsInventory ManagementIndustry StandardsRisk AssessmentCash FlowFinancial Health
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