The quick ratio is one popular measure of a company’s short-term solvency.
Tiraya Adam via Unsplash; Canva
What Is the Quick Ratio?
The quick ratio is a metric that offers investors and analysts a simple look at how liquid a company is in the short term by comparing the value of its most liquid assets (like cash and securities) to its short-term liabilities (like any bills or loan payments that are due in the near term).
A ratio of 1 or more indicates that a company has enough liquid assets to cover its short-term debt obligations. A ratio of less than 1 indicates that a company does not necessarily have sufficient liquidity to handle its short-term liabilities.
The quick ratio is also commonly referred to as the “acid test” ratio. This refers to a quick and simple test gold miners used to use to determine whether samples of metal were true gold or not. Acid would be added to a sample; if it dissolved, it wasn’t gold. If it stood up to the acid, it likely was.
Of course, in the world of mining, solvency means the ability to dissolve, which is a bad thing in gold mining because metals that dissolve in acid aren’t gold. In finance, however, the opposite is true. Here, solvent means “able to pay one’s debts,” so when it comes to the acid test ratio, solvency is a good thing, and results of 1 or higher indicate solvency.
How Is the Quick Ratio Calculated?
To calculate a company’s quick ratio, divide the value of its most liquid assets (i.e., those that can be converted to cash in under three months) by the value of its current liabilities (i.e., money that must be paid out within the next year).
Note: What qualifies as “liquid assets” may vary by company and industry. As a general rule, however, these include cash, cash equivalents, accounts receivable, and marketable securities. These should all be listed on a company’s balance sheet, as should its current liabilities (those coming due within one year).
Quick Ratio Formula
QR = Liquid Assets / Current Liabilities
Quick Ratio Example: Apple (NASDAQ: AAPL)
The following figures are as of March 27th, 2021, and come from Apple’s balance sheet. Numbers are in millions of dollars.
Cash and cash equivalents: $38,466
Accounts receivable: $18,503
Marketable securities: $31,368
Current liabilities: $106,385
QR = Liquid Assets / Current Liabilities
QR = ($38,466 + $18,503 +$31,368) / $106,385
QR = $88,337 / $106,385
QR = 0.83
Based on this calculation, Apple’s quick ratio was 0.83 as of the end of March 2021. This number could be higher if more assets were included in its calculations (see the section about the current ratio below).
What Is a Good Quick Ratio?
A quick ratio of 1 or above indicates short-term solvency, or the ability of a company to meet its financial obligations for the time being. The higher a company’s QR, the better position it’s in—at least in terms of current liquidity.
That being said, too high a quick ratio (let’s say over 2.5) could indicate that a business is overly liquid in the short term because it is not putting its money to work in an efficient manner by hiring, expanding, developing, or otherwise reinvesting in its operations.
Since the quick ratio doesn’t take all assets into account, a ratio of slightly below 1 (e.g., 0.92) isn’t necessarily cause for alarm, as less-liquid assets can be sold, or additional financing can be obtained in the event a company needs more cash to cover upcoming liability payments.
What Does a High Quick Ratio Mean?
A high quick ratio (any quick ratio over 1) means that a company has plenty of cash and cash equivalents to cover any debt payments that may come due within the next year or so. A higher quick ratio (like a 3) means that a company may not be fully leveraging its most liquid assets by using them to expand operations by hiring, acquiring new plants or equipment, or researching and developing new products or services.
What Does a Low Quick Ratio Mean?
A low quick ratio (anything below 1) may indicate that a company is somewhat low on cash and cash equivalents and may need to liquidate certain assets or acquire additional financing by issuing bonds or shares in order to meet upcoming liability payments. An extremely low QR could even indicate that a company is headed toward insolvency.
Quick Ratio vs. Current Ratio: What’s the Difference?
The quick and current ratios are both liquidity ratios. That is, they are both metrics that investors can use to evaluate a company’s ability to pay its debts in the short term. Both ratios are calculated by dividing some of a company’s assets by all of its current liabilities, but they differ in terms of how many asset types are included.
The current ratio includes more asset categories than the quick ratio does in its calculation, so a company’s current ratio should always be higher than its quick ratio.
While the numerator for the quick ratio includes only the most liquid assets (cash, cash equivalents, accounts receivable, and marketable securities), the numerator for the current ratio includes all current assets (cash, cash equivalents, accounts receivable, marketable securities, inventory, and prepaid expenses).
Current Ratio Example: Apple (NASDAQ: AAPL)
Returning to the example above, let’s take a look at how Apple’s current ratio (as of March 27th, 2021) compared to its quick ratio of 0.83. To calculate the current ratio, we’ll include all current assets in the numerator—not just cash and cash equivalents, accounts receivable, and marketable securities. The figures below are in millions of dollars.
Current assets: $121,465
Current liabilities: $106,385
CR = Liquid Assets / Current Liabilities
CR = $121,465 / $106,385
CR = 1.14
Apple’s current ratio was higher than its quick ratio as of the end of March 2021. According to Apple’s current ratio, it had more than enough liquid assets to cover its liabilities for the next year. According to Apple’s quick ratio—the more conservative measure—it didn’t have quite enough liquidity to cover its upcoming liabilities.
