Quick Ratio

Introduction

What is the best current ratio of a specific organization that satisfies you being a stakeholder of the organization. The more the better but up to a certain extent, beyond which, it indicate the poor management in relation to the working capital of the organization. Often the score of the current ratio between 1 and 2 is the best and implies that the organization can easily pay off the liabilities and the obligations that will be due in the current period that is within one year from the reporting date. 

The current ratio greater than one indicates that the organization is not efficient in the management of the working capital. For Instance, management of the organization may have excessive investment in the current asset “Inventory”  to appreciate the figure of the current ratio and to show green liquidity scale to the stakeholders. This manipulation is often costing the organization more than it is benefiting. Organization may be incurring excessive holding costs and opportunity costs which is affecting the other operations of the organization. This is why another significant ratio was required that helps in the assessment of the liquidity and is more reliable than the current ratio.

Quick Ratio

The solution is the Quick Ratio. It is another important measure of the assessment of the liquidity is the Quick ratio. The difference between the both is that Quick ratio is more accurate representative of the liquidity of the specific organization. Quick ratio exclude the figure of the Inventory from the computation as Inventory is not a liquid asset. It is quite time consuming item before it is turned into liquid cash. The other term which is used to refer to the Quick ratio is the acid test ratio.

Formula

The formula which represent the computation of the Quick Ratio is as follows:

• (Current Assets – Inventory)/Current Liabilities

The current assets which primarily make up the numerator part of the Quick ratio is the cash and cash equivalents besides the other current assets that is marketable securities and the accounts receivable. One thing which is common in all of these aforementioned current assets is that are more liquid than the inventories which is the base for the exclusion of the inventories from the computation of the Quick ratio. Remember of all the current assets except the cash, accounts receivable is the most liquid assets.

In relation to a same company, quick ratio is always less than the Current ratio. The reason being is that the numerator in the Quick ratio is always less than the current ratio reason being the exclusion of the figure of the inventory.

Accounts Receivable Justified to be Included in the Quick Ratio Computation?

            The question as is above is pretty debatable. It all depends upon the credit policy of the company. For instance, say the company extends credit for 30 days to its customers then this implies that the accounts receivable are going to be converted in the liquid cash within 30 days and justified to be included in the computation of the Quick Ratio. Similarly, there is valuation consideration of the accounts receivable. They may be valued less than the carrying value owing to the granting of the rebates, discounts to the customers and can tilt the liquidity position a little. Apart from these considerations, experts mostly recognize the accounts receivable as the current asset.