Meaning of Quick Ratio
Quick Ratio is also known as the “Acid-test Ratio” and it is considered as the best measure of a company’s short-term liquidity position.
The quick ratio also indicates the company’s ability to quickly convert its current assets (Except Inventories) into cash and pay off the current liability of the organization.
Quick ratio will help to answer the question: “Whether the organization will be able to pay off its current liabilities even if there is no sales revenue generated?”
Formula for Quick Ratio or Acid – Test Ratio
Quick Ratio = Quick Assets / Quick Liabilities
Whereas, Quick assets consist of all the current assets as used for computation of current ratio except Inventories.
Quick Assets = Current Assets – Inventories
Similarly, Quick Liabilities consists of all the current liabilities used for Computation of Current Ratio.
Quick liabilities = All the current liabilities of the organization.
Based on the above definition we can define the formula of Quick Ratio or Acid-test ratio as follows:
Quick Ratio = Current assets – Inventories / Current liabilities
Standard / Ideal Quick ratio
Generally, a Quick ratio of 1 to 1 is considered satisfactory. Unless Quick asset consists of higher account receivables or Organization is inefficient in the collection of amount from debtors.
Why Inventory is not considered for computation of the Quick ratio?
The main objective of the quick ratio is to determine the company’s ability to pay off its current liabilities instantly. Hence, for computation of quick ratio, only those assets are considered which can be instantly converted into cash. However, Inventory is considered a “Non-cash asset” since it cannot be converted into cash instantly, and even though the organization might be able to sell the inventories instantly but the value or sales consideration might not be at par with the book value of the inventories.
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