Thursday, November 24, 2016

What is a Quick Ratio?

The quick ratio is a liquidity ratio. The formula for the quick ratio equals all cash plus marketable securities and accounts receivables divided by current liabilities. The formula looks like this:

cash + marketable securities + accounts receivables
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current liabilities

By excluding inventory, this key liquidity ratio focuses on the firm's more liquid assets, and helps answer the question "If sales stopped, could this firm meet its current obligations with the readily convertible assets on hand?"  Assuming there is nothing happening to prevent collections, a quick ratio of 1 to 1 or better is usually satisfactory. This has also been called an acid test ratio or a quick asset ratio. The quick ratio can help an investor determine how much debt the company can pay immediately or how much free flowing working capital the company really has to continue operations.

The quick ratio also does not take into account intellectual property or goodwill so that it's true liquid assets are measured against the accounts payable for the next 30 days.  When formulating a quick ratio for stock investment analysis you must dig deep into the understanding of the company's current liabilities to understand whether they classify their current liabilities as those bills due within a month, 90 days or 1 year.  This will change the output of the formula.

You will also have to dig deep into understanding whether the account receivables are accounts that may default or accounts from a large reputable customer that will always pay their bills on time.  This again will change the quick ratio. 

Hope this was helpful,

-Nick Coriano

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About the Author: Nicholas Coriano is a Business Consultant.  He is a graduate of The University of Connecticut Business School and the John Marshall Law School in Chicago.  He has worked at Merrill Lynch, The New York Stock Exchange and is currently a partner at Cervitude Intelligent Relations, which specializes in Investor Relations for companies valued under $1 Billion USD.

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