What Is the Quick Ratio and How to Calculate It

The quick ratio measures a company's ability to cover its current liabilities with cash or near-cash assets. Also known as the acid test, it's worth learning about no matter your industry, because it shows how fast your business can pay back its accounts payable, especially during uncertain economic conditions.

What is the quick ratio formula?

In accounting, the quick ratio is a liquidity test. The test measures a company’s ability to pay back its trade and others payable with quick assets that may readily convert to cash. The formula subtracts inventory from a company’s current assets on its balance sheet and then divides that figure by the number of its current liabilities.

The quick ratio formula is:

Quick ratio = (current assets minus inventory) divided by current liabilities.

To work it out step by step:

• Add up your current assets.
• Subtract the value of your inventory.
• Divide the result by your current liabilities.

What is a liquidity ratio?

Liquidity ratios analyse a company’s ability to fulfill its short-term liabilities. As a small business owner, tracking liquidity is important because it’s your responsibility to ensure the company can follow through on its financial commitments. Lenders also use the ratio to track short-term liquidity when assessing a company’s creditworthiness. If you lack sufficient cash flow, lenders may see you as a risk, making it harder for you to obtain credit.

Compared to the current ratio and the operating cash flow (OCF) ratio, the quick ratio or the acid test, provides a more conservative metric. Generally, the higher the ratio, the better the liquidity position. A perfect quick ratio is 1:1, meaning an organisation has $1 in current assets for every $1 in the company’s current liabilities.

What does your quick ratio mean in business?

Your quick ratio tells you how comfortably your business can meet its short-term obligations. A ratio of 1 means you have just enough liquid assets to cover your current liabilities, a higher number gives you more breathing room, and a lower number flags potential strain.

Quick ratio vs acid test ratio

You can use the terms “acid test ratio” and “quick ratio” interchangeably. Today, accountants use the acid test to show how well a company can pay off its total current liabilities using only quick assets that can be converted to cash, not current assets.

In short:

• Same formula: both subtract inventory from current assets, then divide by current liabilities.
• Same purpose: both measure whether you can cover short-term liabilities without selling inventory.
• Same result: acid test is the older term; quick ratio is the modern one.

What are quick assets?

Quick assets are liquid assets that can be converted to cash within 90 days. Generally, quick assets include: 

• Cash and cash equivalents
• Accounts receivable
• Marketable securities, or short-term investments

Leaving inventory out gives you a more conservative picture, because inventory isn't always quick or certain to sell, and the price it fetches can vary. That's why some lenders prefer the current ratio, which includes inventory, when measuring overall worth. The quick ratio takes the stricter view: it shows whether you could cover your short-term liabilities by turning your quick assets into cash, without relying on selling inventory.

What are current liabilities?

Current liabilities represent financial obligations a company owes to another party that are due within a year. Non-current debt is due at a later time.

Hopefully, you’ve been meticulously recording your company’s short-term liabilities and unpaid invoices. Common examples of current liabilities include loans, interest, taxes, accounts payable, services, and products. Confirm that you’ve accounted for each in the quick ratio formula.

• Loans: Short-term borrowings, plus the portion of any long-term loan due within the year.
• Interest: Interest owed on outstanding loans and credit facilities.
• Taxes: Amounts assessed and payable within the year, such as GST and corporate income tax.
• Accounts payable: Money owed to suppliers for goods or services you've already received.
• Products: Amounts owed for stock or materials bought on credit.

What are current assets?

Current assets include all of a company’s assets that it can reasonably expect to sell or use within an accounting year without losing value. Non-current assets, such as land and goodwill, are long-term assets because their full value won’t be recognised within an annual accounting cycle.

A company’s current assets might include:

• Cash and cash equivalents
• Accounts receivable
• Marketable securities
• Prepaid liabilities
• Stock inventory

Cash and cash equivalents

Cash is your most liquid asset, including paper bills, coins, cheques, and money orders on hand. Cash equivalents, such as money market funds and business bank accounts, are mostly liquid and quick to access.

Accounts receivable

Accounts receivable (AR) is the value of outstanding money owed to your business from sales made on credit. It only counts as a current asset if customers pay within your operating cycle, so stay on top of collections to keep your quick ratio accurate and avoid cash flow problems from late payers.

Marketable securities

Marketable securities are investments you can sell quickly (usually within 90 days), like shares and government bonds. Because their price moves with the market, record what they're worth right now on your balance sheet, not what you paid for them.

Prepaid liabilities

If you've paid in advance for something you'll use soon, like leased equipment or a legal retainer, that prepayment counts as a current asset. It counts while you still have the benefit coming to you and you'll use it up within the year.

Stock inventory

Inventory covers everything you plan to sell, plus the raw materials you need to make it. To value it, add up your finished products and anything still being made, then include the expenses you paid for materials. If you also pay to store or ship that stock, subtract those costs from the total.

How to calculate the quick ratio: An example 

The quick ratio formula is easiest to grasp with real numbers.

For example, let’s say a company has $250,000 in current assets: $50,000 of which is inventory, and $100,000 in current liabilities. Take out the inventory and you're left with $200,000 in quick assets. Divide that by the $100,000 in liabilities, and the quick ratio is 2:1. In other words, the company has $2 in quick assets ready for every $1 it owes in the short term.

The importance of using a quick ratio formula 

Your quick ratio tells you a lot in a single number, so why crunch it by hand? Our cloud-based system works it out for you and keeps your current assets and liabilities in real-time reports, so you can spend less time on the numbers and more time growing your business.