The quick ratio, sometimes called the acid-test, is a more stringent test of liquidity than the current ratio. This is because it removes inventory from the equation. Inventory is the least liquid of all the current assets. A business has to find a buyer if it wants to liquidate inventory, or turn it into cash. Finding a buyer is not always easy.
Calculation of the Quick Ratio
The quick ratio is calculated from balance sheet data.Current Assets - Inventory/Current Liabilities
Example:
If a business firm has $200 in current assets and $50 in inventory and $100 in current liabilities, the calculation is $200-$50/$100 = 1.50X. The "X" (times) part at the end is important. It means that the firm can pay its current liabilities from its current assets (less inventory) one and a half times over.
Liquidity ratios are used to evaluate the firm's ability to pay its short-term debt obligations such as accounts payable (payments to suppliers) and accrued taxes and wages. Short-term notes payable to a bank, for example, may also be relevant.
Interpretation and Analysis
This is obviously a good position for the firm to be in. It can meet its short-term debt obligations with no stress. If the quick ratio was less than 1.00X, then the firm would have to sell inventory to meet its obligations So, a quick ratio great than 1.00X is better than a quick ratio of less than 1.00X with regard to maintaining liquidity and not being forced into the position of having to sell inventory.
