The Quick Ratio is also called the Acid Test to tell if a business has sufficient cash or near-cash reserves to carry the business through slow periods.
Allow your Current Liabilities to exceed your quick “cash” assets; you have allowed cash outflows to overtake cash inflows. When this happens, be ready for angry calls from those you owe money aggressively asking when you will pay them.
A Quick Ratio, also called the Acid Test, is a Liquidity Ratio that quantifies whether there are enough current assets to cover current liabilities. This ratio indicates a company’s capacity to maintain operations as usual with current cash or near-cash reserves in slow periods.
The Quick Ratio establishes how quickly a company can convert its “quick assets” (cash, cash equivalents, short-term investments, marketable securities) into cash to pay off its current liabilities within 90-days.
If a company has enough quick assets to cover its total current liabilities, the firm will be able to pay off its obligations without having to sell off any long-term or capital assets. This is the “acid test” for a company, signifying the degree a company’s current liabilities are covered by the most liquid of its assets.
The formula for calculating the Quick Ratio or Acid Test is as follows:
(Cash + Cash Equivalents + Short-Term Investments + Current Receivables) / Current Liabilities
A Quick Ratio of 1 indicates that quick assets equal current liabilities. This means that the company could pay off its current liabilities without selling any long-term assets. A Quick Ratio of 2 shows that the company has twice as many quick assets than current liabilities.
Above 1: shows that there are more quick assets than current liabilities.
Less than 1: shows that there are more current liabilities than quick assets.