# Quick ratio or acid test ratio

*Define, explain and interpret quick ratio.*

Quick ratio (also known as “acid test ratio” and “liquid ratio”) is used to test the ability of a business to pay its short-term debts. It measures the relationship between liquid assets and current liabilities. Liquid assets are equal to total current assets minus inventories and prepaid expenses.

## Formula

The formula for the calculation of quick ratio is given below:

## Example 1

The following are the current assets and current liabilities of PQR Limited:

**Current assets:**

- Cash: $2,400
- Accounts receivable: $12,000
- Inventory: $16,000
- Prepaid expenses: $600

**Current liabilities:**

- Accounts payable: $11,600
- Accrued parables: $1,800
- Notes payable: $600

Calculate quick ratio of PQR Limited.

## Solution

= 14,400*/14,000**

= 1.03

(rounded to two decimal places)

*Liquid assets:

= (Total current assets) – (Inventories + Prepaid expenses)

=$31,000 – ($16,000 + $600)

= $31,000 – $16,600

= $14,400

** Current liabilities:

= $11,600 + $1,800 + $600

= $14,000

## Significance and Interpretation

Quick ratio is considered a more reliable test of short-term solvency than current ratio because it shows the ability of the business to pay short term debts immediately.

Inventories and prepaid expenses are excluded from current assets for the purpose of computing quick ratio because inventories may take long period of time to be converted into cash and prepaid expenses cannot be used to pay current liabilities.

Generally, a quick ratio of 1:1 is considered satisfactory. Like current ratio, this ratio should also be interpreted carefully. Having a quick ratio of 1:1 or higher does not mean that the company has a strong liquidity position because a company may have high quick ratio but slow paying debtors. On the other hand, a company with low quick ratio may have fast moving inventories. The analyst, therefore, must have a hard look on the nature of individual assets.

## 18 Comments on Quick ratio or acid test ratio

If quick ratio is very high, it means company has high % of liquid assets that shows company is not using their assets properly because company have their asset motionless.

Too much good explanation with best example and easy to understand

so do further for the betterment of people our prayers will be with you.

Thanks Liaqat. I need your prayers.

In this solution quick ratio is 1.03..

so, can we write it as 1:03?????

Shifa, you can write it as 1.03:1, not 1:03.

= 14,400 : 14,000

= 1.03 : 1

Thanks a lot sir………………….

This is the best explanation or interpretation of ratio that i have seen,each and every ratio is very practical and show real time scenario of market /company /industry, thanks and please keep it up.

if my quick ratio is 5.86:1, then what is the firm’s position

If loans and advances are together ,am I suppose to take it in liquid assets.

This is a good explanation but I want to know the perspectives of different stakeholders in ratio e.g if quick ratio is increased then how it effects on customers and owners etc. and also industry to industry it varies so I want that information that if their is some service of manufacturing industry then decreased or increased trends will effect them or not.

what is formula of acid-test ratio

waal great stuff. i wish to get a high mark on my assignment…God bless you

my current ratio is 0.78 and quick ratio is 0.59 how do I advice someone granting a 3 months loan to such company ?

helps me a lot when doing assignments

Is Unearned Revenue included in computing the total current liability?

If quick ratio is 3.06:1 then what will be the interpretation ???

Sir.. Why we consider bank od while calculating quick ratio? Why the conversion of quick asset into cash or cash equivalent is expected to pay the bank od,which has no need of a really quick repayment ?

If the quick ratio deecreased what effect it has to the economy?