Quick ratio is a financial measurement to determinate company ability to cover its short term debt with assets that can be quickly converted into cash. In other words, it is a short term liquidity indicator that determinate company’s ability to pays its short term liabilities with its most liquid assets. For rigid short term assets usually are considered any short term assets then can be quickly transferred into cash like at close to its book value like: cash and cash equivalents, marketable securities and accounts receivable.
The formula for calculating quick ratio is:
Quick Ratio = Quick Assets / Current Liabilities
Where quick assets is the sum of: Cash and cash equivalents
Quick assets = Cash and cash equivalents + Marketable securities + Accounts receivable
Another way to calculate quick assets is:
Quick assets = Current Assets - Inventory - Prepaid expenses
Quick ratio provides and estimate of how solvent a company is without the need of relying on its cashflow or to sell any of its more tangible assets in order to pay its short term obligations. One think to keep in mind is that the sometimes larger quick ratio might be as a result of company customers ability to pay. If the company has large number of account receivables that might not be as liquid as some of the customers have the potential of not meeting its obligations.
Generally quick ratio of 1 a1nd larger is considered an acceptable and normal value. This means that a company with quick ratio of 1 has enough liquid assets to hover all of it short term obligations. If the quick ratio is below 1 this might mean that the company might not be able to cover its short term obligations and relay on its future cashflows. Generally the higher the quick ratio is, the better a company’s liquidity and financial health is. Generally the quick ratio is considered as a more strict measure than the current ratio because the current ratio includes all current assets that might not be as liquid.
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