Prepaid expenses, though an asset, cannot be used to pay for current liabilities, so they’re omitted from the quick ratio. It’s also known as the acid-test ratio and is worth learning—no matter your industry. The quick ratio helps you track your liquidity, which is your ability to pay bills in the short term. Using the quick ratio can help you avoid cash flow problems and maintain good relationships with your creditors and suppliers.
In other words, a company shouldn’t incur a lot of cost and time to liquidate the asset. For this reason, inventory is excluded in quick assets because it takes time to convert into cash. The quick ratio provides a simple way of evaluating whether a company can cover its short-term liabilities very quickly. This is important for a business because creditors, suppliers, and trade partners expect to be paid on time. But unlike the first company, it has enough cash to meet that supplier payment comfortably — despite its lower quick ratio.
How To Find a Firm’s Quick Ratio
Charlene Rhinehart is a CPA , CFE, chair of an Illinois CPA Society committee, and has a degree in accounting and finance from DePaul University. When it comes to having a profitable business, using cash wisely is necessary. To learn more about this ratio and other important metrics, check out CFI’s course on performing financial analysis. Our goal is to deliver the most understandable and comprehensive what does a high quick ratio mean explanations of financial topics using simple writing complemented by helpful graphics and animation videos. We follow strict ethical journalism practices, which includes presenting unbiased information and citing reliable, attributed resources. Our team of reviewers are established professionals with decades of experience in areas of personal finance and hold many advanced degrees and certifications.
- If we compare this number with the quick ratios of other companies, we will know how good it is compared to others.
- The quick ratio does not take into account the collectability of accounts receivables.
- However, the current ratio includes inventory and prepaid expenses in assets because assets are defined as anything that could be liquified within a year for the current ratio.
- However, if you want to compare two companies in the same industry, this ratio can help determine which one has better liquidity.
It deals with other small businesses that may or may not have a strong financial uphold on their cash flow. Cash flow is an essential metric in evaluating the health of a business. Investors and analysts can use quick ratios to determine whether a company has enough cash on hand to cover its current expenses—a key sign of financial health. This may include cash and savings, marketable securities (stocks and bonds), and accounts receivable (money owed to the company by customers and clients).
Quick Ratio
On the other hand, a company could negotiate rapid receipt of payments from its customers and secure longer terms of payment from its suppliers, which would keep liabilities on the books longer. By converting accounts receivable to cash faster, it may have a healthier quick ratio and be fully equipped to pay off its current liabilities. The Quick Ratio, also known as the Acid-test or Liquidity ratio, measures the ability of a business to pay its short-term liabilities by having assets that are readily convertible into cash.
