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# Quick Ratio:

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## Definition and Explanation:

Quick ratio is also known as liquid ratio or acid test ratio. Current ratio provides a rough idea of the liquidity of a firm so subsequently a second testing device was developed named as acid test ratio or quick ratio. It establishes relationship between liquid assets and current liabilities. In many businesses a significant proportion of current assets may comprise of inventory. Inventory, by nature, cannot be converted into ready cash abruptly. The term liquid assets does not include inventory.

## Formula:

Following formula is used to calculate quick ratio:

Quick ratio = Liquid (quick) assets / Current Liabilities

The term liquid or quick assets includes all the current assets minus inventory at prepaid expenses.

## Example:

From the following balance sheet calculate (a) current ratio and (b) quick ratio:

 Liabilities \$ Assets \$ Equity share capital 2,00,000 Land & building 80,000 General reserve 90,000 Machinery 1,20,000 Sundry creditors 60,000 Cash 10,000 Bills payable 20,000 Bank 30,000 Bank overdraft 30,000 Stock 1,40,000 Provision for tax 5,000 Short-term investments 25,000 Proposed dividend 10,000 Sundry debtors Outstanding salaries 5,000 Less provision 36,000 Long term loans 60,000 Bills receivable 10,000 Prepaid insurance 9,000 Preliminary expenses 20,000 4,80,000 4,80,000

Solution:

Current ratio = Current assets / Current liabilities

Current assets are cash, bank, stock, investments, sundry debtors (net), bills receivable and prepaid insurance.=  \$10,000+30,000 + 1,40,000 + 25,000 + 36,000 + 10,000 + 9,000 = \$2,60,000.

Current liabilities are sundry creditors, bills payable, bank overdraft, provision for tax, proposed dividend and outstanding salaries

= 60,000 + 20;000 + 30,000 + 5,000 + 10,000 + 5,000

= \$1,30,000

Current ratio = 2,60,000/1,30,000

= 2 : 1

Quick ratio = Quick assets / Current liabilities

Quick assets = Current assets - (Stock + Prepaid expenses)

= 2,60,000-(1,40,000+ 9,000)

= \$1,11,000

Quick ratio = 1,11,000 / 1,30,000

= 0.85 : 1

## Interpretation of Quick Ratio:

As quick ratio eliminates inventory and prepaid expenses for matching against current liabilities therefore it is a more rigorous test of liquidity as compared to Current ratio. When used along with Current ratio it gives a clearer picture of business's liquidity position. Rule of thumb for acid test ratio is 1 : 1 i.e., if business liquid assets are 100 percent of its current liabilities it is considered to be having fairly good current financial position. However care must be exercised in depending upon too much on rule of thumb stated above. Just like any other ratio the interpretation of acid test ratio also depends on circumstances discussed under Current ratio. Interpretation of this ration is also subject to the same factors and conditions as the Current ratio.

More study material from this to

## More study material from this topic:

 Meanings, Nature and Usefulness of Ratios Analysis Interpretation of Ratios Important Factors for Understanding Ratios Analysis Significance and Usefulness Ratios Analysis Classification of Ratios Analysis of Short Term Financial Position or Test of Liquidity Current Ratio Quick/Acid Test/Liquid Ratio Absolute Liquid Ratio Inventory/Stock Turnover Ratio Debtors / Receivable Turnover Ratio Creditors / Payables Turnover Ratio Working Capital Turnover Ratio Profitability Ratios Gross Profit Ratio (GP Ratio) Operating Profit Ratio Net profit ratio (NP ratio) Earnings Per Share Ratio Operating ratio Expense ratio Solvency ratios - Test of Long Term Solvency Debt-equity Ratio Debt Service Ratio or Interest Coverage Ratio Fixed Assets Ratio Debts to Total Funds or Solvency Ratio Reserves to Capital Ratio Capital Gearing Ratio Proprietary Ratio Accounting Ratios Formulas Limitations of Ratios Analysis

A D V E R T I S E M E N T

 Financial Accounting Topics Introduction to Accounting ---------------------------------------------------------------------------- Transactions and Accounting Equation ---------------------------------------------------------------------------- Analysis of Business Transactions ---------------------------------------------------------------------------- Journal, Ledger and Trial Balance ---------------------------------------------------------------------------- Accounting for Bills of Exchange ---------------------------------------------------------------------------- Special Journals ---------------------------------------------------------------------------- Cash Book ---------------------------------------------------------------------------- Bank Reconciliation Statement ---------------------------------------------------------------------------- Final Accounts ---------------------------------------------------------------------------- Work Sheet ---------------------------------------------------------------------------- Capital and Revenue Items ---------------------------------------------------------------------------- Valuation of Inventories ---------------------------------------------------------------------------- Accounts of Non-profit Making Organizations ---------------------------------------------------------------------------- Statement of Cash Flows ---------------------------------------------------------------------------- Accounting Ratios Analysis ---------------------------------------------------------------------------- Depreciation, Provisions and Reserves ---------------------------------------------------------------------------- Accounting Dictionary ---------------------------------------------------------------------------- Financial Calculators

 Managerial Accounting Topics Financial Statements ---------------------------------------------------------------------------- Cost Volume Profit Relationship ---------------------------------------------------------------------------- Variable Costing System ---------------------------------------------------------------------------- Materials and Inventory Cost Control ---------------------------------------------------------------------------- Activity Based Costing System ---------------------------------------------------------------------------- Standard Costing and Variance Analysis ---------------------------------------------------------------------------- Balanced Scorecard ---------------------------------------------------------------------------- Capital Investment Analysis/Capital Budgeting