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The quick ratio is also known as the acid test ratio, becasue it privoeds the acid test of whether the company has sufficient resources (receivables and cash) to settle its current liabilities.
The quick ratio (acid test ratio) formula is:
Quick raito = (Current assets – inventory) /Current liabilities
We know the price of inventory is unstable because of the market condition. The inventory should be eliminated from current assets. Like the current ratio, it need to consider the nature of the business. Norms for the quick ratio range from 1 to 0.7.
In the quick ratio, the asset includes:
- bank, cash and short-term investments
- trade receivables.
Excluding prepayments and inventory.
The liabilities would usually include:
- bank overdraft which is technically repayable on demand
- trade payables, tax and social security.
Income taxes may be excluded.
Here, we should take care of the status of the bank overdraft. A company with a low quick ratio may actually have no problem in settling accounts payable if sufficient overall overdraft facilities are available.
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