Investment Formula Description

Quick ratio is a investment formula to measure company's liquidity and ability to meet its debt obligations.

 It is also an indicator for company's short-term liquidity by measuring its most liquid assets such as cashes on hand and cashes in banks. Based on formula, investors can see that inventories is deducted from current assets because inventories take some time to convert to cashes. Hence, quick ratio is actually more conservative than current ratio or working capital ratio, which is another investment formula to measure company's short- term liquidity. Some companies like construction companies that need longer period to convert its inventories ( Properties ) into cash. In this case, using current ratio to measure the company's short-term liquidity might overestimate a company's short-term financial strength. The better investment formula to measure the company's short-term liquidity in this situation is quick ratio. Sometimes, quick ratio is also referred as acid test ratio. A healthy company should have at least value 1 of quick ratio or higher  to prove the it has the ability to meet all the short-term debt obligations excluding inventories.

Investment Formula

Quick Ratio = ( Current Assets - Inventories ) / Current Liabilities

Investment Formula Examples

Corporation XYZ has $50,000 current assets, which consists of $30,000 inventories and $40,000 current liabilities at the end of this financial period. The quick ratio calculation is as following.

Quick Ratio = (Current Assets - Inventories ) / Current Liabilities = ( 50,000  - 30,000 ) / 40,000 = 0.5

In this case, corporation XYZ only has 0.5 quick ratio. If corporation XYZ is not able to convert the inventories to cash, it does not have ability to pay all its short-term debts since it only have $20,000 most liquid assets.

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