What is the quick ratio?

Definition

The quick ratio is liquid current assets, with inventory left out, divided by current liabilities. On the books, this is a liquidity reading, not a ledger account you debit.

A wholesale bakery uses it when the flour room is full and checking is thin. The question is whether near-term bills can be covered with cash and invoices, without waiting for the flour to sell.

It is not a Balance Sheet line. The books already hold the cash, the invoices, the stock, and the bills; this reading restates the liquid pieces against what is due soon.

Stay with the inventory-out version when you read it. A version that keeps inventory in is a different ratio.

Where it shows up

Balance Sheet: Related to cash and receivables against current liabilities. Inventory is left out.

Cash flow: Related to cash that is actually available soon.

P&L: Related to profit sitting in inventory, which this ratio ignores.

See also: Current Ratio · Current Liabilities · Liquidity

When you look at your Balance Sheet, add cash and cash equivalents and accounts receivable, then divide by current liabilities. Leave inventory out on purpose.

When the reading is above one, cash and invoices more than cover near-term bills. When it is below one, the bakery cannot cover those bills without selling stock or finding other cash.

The Income Statement does not print this ratio. Revenue can sit in unsold bread, which this reading ignores.

On the Statement of Cash Flows, collections and vendor payments are the cash events. This page stays on whether the liquid pieces cover the bills, not on a period cash total.

How it works

Start with cash and near-cash. Add invoices customers already owe.

Do not add inventory. Flour and finished bread have to sell and collect before they can pay a mill bill.

Divide that liquid total by current liabilities. Accounts payable, payroll taxes, and the current piece of a loan are the usual bills in the denominator.

A result of one means liquid assets equal the near-term bills. A result of 0.8 means the bakery has eighty cents of cash and invoices for every dollar due soon.

Stay with this inventory-out reading. Folding the flour back in is the current ratio, a different page.

Some lenders write this test into a covenant. Missing the floor can put the loan in default even if leftover profit looks fine.

Do not treat a high current-asset total as proof this reading is fine. Fat inventory can make the broader current picture look healthy while this ratio is still short.

Cash position is the spendable piece of the numerator. Invoices that will not clear before the due date are weaker cover than cash already in checking.

Example

Hearth Lane Bakery, a wholesale shop, holds $8,000 in cash and $20,000 of grocer invoices. Current liabilities sit at $35,000, and the flour room holds $60,000 of stock.

Add cash and invoices: $8,000 plus $20,000 is $28,000. Divide by $35,000, and the reading is 0.8.

Inventory is left out on purpose. Counting the $60,000 of flour would push the broader current picture well above one, which is not this test.

Friday's mill bill still needs cash. The 0.8 reading says liquid cover is short even though the asset total looks large.

If $12,000 of those invoices clear this week, cash rises and receivables fall by the same amount. The reading stays 0.8, but more of the numerator is spendable.

If the bakery draws $10,000 on a line of credit, cash and current liabilities both rise by $10,000. Friday is easier to fund, while the ratio barely moves.

The bakery does not post a line that says this ratio. The books already hold the cash, the invoices, the stock, and the bills; you leave the stock out and divide.

Common mix-ups

This ratio is not the same as the current ratio. The current ratio keeps inventory in; this page leaves it out on purpose.

This ratio is not the same as cash on hand. Cash is one piece of the numerator; invoices sit in the same total.

This ratio is not the same as working capital. Working capital is a dollar cushion of current assets minus current liabilities; this page is a coverage rate that ignores inventory.

Related terms

• Current Ratio: Current assets divided by current liabilities.
• Current Liabilities: Obligations due within the next twelve months.
• Cash And Cash Equivalents: Bank balances and near-cash holdings that can be spent immediately.
• Accounts Receivable: Money customers owe the business for goods or services already delivered.
• Liquidity: How readily the business can cover near-term obligations with available cash.
• Working Capital: Current assets minus current liabilities, showing short-term operating cushion.
• Inventory: Goods held for sale or used to produce goods for sale.
• Covenant: A condition in a loan agreement the borrower must keep meeting.