302763 Flashcards
Quick Ratio
The quick ratio is a liquidity ratio that measures the firm’s ability to discharge currently maturing obligations from most liquid (quick) current assets, cash, marketable equity securities (MES), and accounts receivable (AR). It is more precise than the current ratio because only highly liquid assets are used (i.e., inventories—less liquid and more likely to incur losses in the event of liquidation—and prepaid assets are excluded). It measures immediate liquidity.
The computation is Quick assets ÷ Current liabilities or (Cash + MES + AR) ÷ Current liabilities.
There are limitations on use of this ratio. Accounts receivable may be subject to a lengthy collection period and may have to be factored at less than carrying value to convert to cash immediately. Marketable equity securities are subject to fluctuations in market conditions that affect their liquidation amount.
The acid test ratio shows the ability of a company to pay its current liabilities without having to:
reduce its cash balance.
liquidate its inventory.
borrow additional funds.
collect its receivables.
liquidate its inventory.
Acid test ratio = Quick assets ÷ Current liabilities
Quick assets = Cash + Cash equivalents + Net receivables + Marketable securities
These “quick assets” do not include merchandise inventory, so the focus is on the ability of other current assets to pay liabilities.
