Startup businesses generally have a lower quick ratio compared to more mature businesses, because the startups typically have more debt. For example, if the operating profit is $60,000 and sales are $100,000, the operating profit margin is 60%. Amanda Bellucco-Chatham is an editor, writer, and fact-checker with years of experience researching personal finance topics.
Less formal reports (i.e. not required by GAAP external reporting rules) may simply report current assets without further breaking down balances. Both ratios include accounts receivable, but some receivables might not be able to be liquidated very quickly. As a result, even the quick ratio may not give an accurate representation of liquidity if the receivables are not easily collected and converted to cash. If a company increases its accounts payable by taking longer to pay suppliers, it may have more cash and a higher quick ratio. A company’s quick ratio may decrease if customers delay payments or default on their debts. Another strategy for improving a company’s quick ratio is to reduce its accounts payable.
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On the other hand, a company could negotiate rapid receipt of payments from its customers and secure longer terms of payment from its suppliers, which would keep liabilities on the books longer. By converting accounts receivable to cash faster, it may have a healthier quick ratio and be fully equipped to pay off its current liabilities. It indicates that the company is fully equipped with exactly enough assets to be instantly liquidated to pay off its current liabilities. For instance, a quick ratio of 1.5 indicates that a company has $1.50 of liquid assets available to cover each $1 of its current liabilities.
For example, suppose a company has a high level of inventory that can be quickly sold and converted into cash. In that case, the Current Ratio may be a more appropriate quick ratio is another commonly used term for the measure of liquidity. It’s relatively easy to understand, especially when comparing a company’s liquidity against a target calculation such as 1.0.
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Though a company may be sitting on $1 million today, the company may not be selling a profitable good and may struggle to maintain its cash balance in the future. There are also considerations to make regarding the true liquidity of accounts receivable as well as marketable securities in some situations. Since it indicates the company’s ability to instantly use its near-cash assets (assets that can be converted quickly to cash) to pay down its current liabilities, it is also called the acid test ratio. An « acid test » is a slang term for a quick test designed to produce instant results.
The quick ratio is therefore considered more conservative than the current ratio, since its calculation intentionally ignores more illiquid items like inventory. However, that risk is vastly mitigated for a company whose credit terms to its customers are less favorable than those it receives from its suppliers. I.e., customers are required to pay invoices in 30 days, but the firm has 90 days to pay its suppliers. For such firms, the quick ratio is fairly accurate, as it’s unlikely that bills will come due that depend on future receipts. By understanding the quick ratio and its significance, investors and analysts can make better decisions when evaluating companies and their financial health.