The quick ratio reflects a business’s ability to make bill and loan payments in the short term (three months).
The quick ratio (also called the acid test ratio) tells a business if it can cover its debts for the coming quarter (three months). In this respect it’s similar to the current ratio, which does the same job but over a 12-month period.
In accounting terms, the quick ratio determines if a business’s short-term (or current) liabilities – the amounts it owes in the coming three months – can be covered by its liquid assets.
Liquid assets include cash and things that can be changed into cash within three months. They ignore assets that may be difficult to liquidate quickly, such as inventory.
The formula for calculating quick ratio is:
Quick Ratio = Liquid Assets / Current Liabilities
A quick ratio above 1.0 generally indicates that the business can pay its debts.
A business with a high quick ratio can look more attractive to investors and can sometimes get better interest rates from lenders. But if it’s too high, it could also mean the business isn’t reinvesting its cash or putting it to use.
If the business has a quick ratio less than 1.0, it may need to consider its current assets, assess the risk, and decide if it has enough liquid assets. If not, it needs to prepare in case this becomes a problem for continuing in business.
Quick ratios can vary by industry. Retail stores, for example, have low quick ratios due to their dependence on inventory. It’s therefore best to compare quick ratios with businesses in the same industry.