Quick ratio and current relationship meaning

Current Ratio vs Quick Ratio | Top Differences | Which is better? The quick ratio is a variation of the current ratio and is to be more conservative estimate than the current ratio. The article discusses in detail about the formula. In finance, the quick ratio, also known as the acid-test ratio is a type of liquidity ratio which measures the ability of a company to use its near cash or quick assets to extinguish or retire its current liabilities immediately. Quick assets include those current assets that presumably can be quickly Formula. Quick Ratio . The current ratio and the quick ratio are both liquidity ratios that measure current assets by current liabilities as shown in the formula below.

Finance: Liquidity Ratios Explained

As mention above, this ratio exclude inventories from its calculation. As we know, inventories could talk long time to convert into cash. It is depending on the types of the business and market that entity operating in. Some inventories take a day to convert into cash, some require months or even more than one year. Another advantages of quick ratio is that this ratio is very easy to understand and straight forward. It can help the users of ratio who doe not have deep skill in accounting and financial to understand this ratio easily.

Quick Ratio: Meaning, Interpretation and Significance (With Example)

For example, some of operation managers who their KPI are including quick ratio could see and understand the ratio. This ratio is measure as the percentages. So if the ratio is higher than the target, that mean some actions are required to fix. Set as KPI and compare its with different size of entity. This ratio compare current assets and current liabilities and the result measure as percentages. That mean we can compare it to the others entity or competitors which have different size and nature.

Although quick ratio has some advantages, its also has certain disadvantages that the users especially the specialist who is responsible for analyst and interpret this ratio should be aware of. Here are those disadvantages of quick ratio: It is the financial indicator. As we know this ratio use the financial information to analyst the liquidity position of entity. This financial information could be influence by management of entity if they want. The sum of money that is yet to be received from the debtors of the company is called accounts receivable; including accounts receivable is criticized by some of the analysts because there is less certainty in liquidation of accounts receivable! Then divide the figure by current liabilities to get to the quick or acid test ratio.

Quick Ratio - Meaning, Formula and Assumptions

Current Ratio vs Quick Ratio — Interpretation First, we will interpret the current ratio and then quick ratio. If a company has less than 1 as their current ratio, then the creditors can understand that the company will not be able to easily pay off their short term obligations.

And if the current ratio of the company is more than 1, then they are in a better position to liquidate their current assets to pay off the short term liabilities. But what if the current ratio of a company is too higher? There are actually two ways of looking at it.

Quick Ratio: Meaning, Interpretation and Significance (With Example)

First, they are doing exceptionally good so that they can liquidate their current assets so very well and pay off debts faster. Second, the company is not able to utilize its assets well and thus, the current assets are much more than current liabilities of the company.

It is similar It is similar with prepaid expenses. Prepaid expense is the amount paid in advance for goods and services to be received in future.