Quick Ratio Calculator

A company can only pay its short-term liabilities that are due within a year with assets that can be quickly converted into cash? That is the question to which the liquidity ratio provides an answer. The liquidity ratio consciously excludes inventories since their sale takes time. In financially difficult times, companies often have to sell inventories at a discount or they remain unsold. Bankers also refer to this value as "acid test ratio". This calculation tool allows you to determine the liquidity ratio from the balance sheet and also offers a conversion option. If you enter any value in one field, the tool calculates the corresponding value.

What does the liquidity ratio measure?

The liquidity ratio compares a company's most liquid assets to its obligations that are due within one year. The numerator consists of three positions on the balance sheet that can be converted into cash with little effort: Cash is readily available. Marketable securities such as government bonds or stocks can usually be sold at a price close to their market value within a day. Accounts receivable from goods and services supplied are settled according to payment terms with customers, and are normally paid off within 30 to 90 days. The sum of these three positions is divided by the short-term liabilities to obtain the liquidity ratio.

Some analysts use an alternate method to calculate the same value; they start with total current assets and subtract those that take time to liquidate.

Both methods will give the same result. This calculator uses the additive method by default as it represents the composition of liquid assets through a separate entry for cash, securities and receivables from supplies and services.

Why is it called an "acid test"?

The term derives from an old method of testing gold using acid. Real gold passes the test while fakes fail it. The same principle applies to today's ratio versus year-end. Inventories can artificially inflate the turnover ratio, sometimes even above 1.0. But when you strip out inventories, the true liquidity level could be significantly lower. The "acid test" asks a tougher question: What debts must be paid this year? And how would you pay them if you couldn't sell a single item from inventory?

This is how you determine the current ratio from the balance sheet:

You need four values that can all be found in the top section of your balance sheet.

1. Cash and cash equivalents.

2. Marketable securities. These are sometimes referred to as short-term investments.

3. Claims for deliveries and services.

4. Total current liabilities. Add up the first three positions and divide by the result to obtain the current ratio.

This can be interpreted both ways.

Because the formula contains only one relationship, you can manipulate the values to find missing numbers. Leave the appropriate fields blank and enter the other values. This is especially useful when creating a target model. If you specify three inputs and select the desired ratio, a tool will calculate the fourth required value.

Example calculation:

A company has $200,000 in cash, $50,000 in marketable securities and $150,000 in accounts receivable. Short-term liabilities are $300,000.

At first sight this seems very healthy. However, let's assume that receivables have risen to 400,000 because an important customer no longer pays on time. While the ratio in the balance sheet rises to 1.83, actual liquidity actually deteriorates. This value must always be considered in connection with its composition. The following table shows the individual terms and corresponding values from the example above.

What is a good liquidity ratio?

In most industries it is usually between 1.0 and 1.5. If it falls below 1.0 there are legitimate concerns about the company's ability to pay short-term debts without using up inventory or taking on new debt. If it rises above 2.0 or 3.0, then the problem is reversed. These funds should be generating profits or being returned to shareholders. Why are they being used so inefficiently? The industry context also matters. A software company with relatively low working capital needs can usually have values over 2.0 without causing problems. On the other hand, manufacturers or retailers with long payment terms can often operate smoothly even if they reach a value of 0.8.

More important than individual numbers for a quarter is the trend. If the metric moves over three periods from 1.4 to 1.1 and then further down to 0.9 this sends a much stronger signal than if just one single quarter hits 0.9. Regardless of whether it's an up or down move, swings within a period that exceed .3 should normally be investigated more closely.

Liquidity ratios, turnover ratios, cash ratios.

These three liquidity ratios form a series of increasingly strict criteria. The current ratio considers all short-term assets including inventory and prepaid expenses. The quick ratio excludes those assets that take longer to convert into cash. The cash ratio is the most stringent, comparing only cash and cash equivalents with short-term liabilities. You can view all three at once by opening the liquidity ratios calculator.

The difference between the turnover ratio and liquidity ratio lies in the inventory itself. A large gap means that a large portion of the company's apparent liquidity is tied up in stock, meaning it must be sold before it can be used to pay off debts.

What's behind this number:

Even a seemingly obvious ratio of 1.4 hides many details. If nearly all assets are receivables from customers who do not want to pay, then there is no real liquidity. For small companies with low turnover, marketable securities may not be converted into cash in times of recession. Short-term liabilities can also include positions that have flexible terms and where actual cash payment on a particular day is not required. This ratio represents a snapshot at one point in time and is not a forecast for the coming months. Before drawing conclusions based on this ratio, you should read the footnotes to the annual report and perform an analysis taking into account the statement of cash flows.

Areas of application for liquidity ratio.

Financial institutions examine this ratio before approving credit lines. If the figure is low, then the debtor may need to sell inventories in order to make payments, which increases the risk of problems. Investors use it as a rough filter when selecting companies within the same industry. Within an organization, CFOs and finance professionals track this value on a monthly basis in order to detect issues early before a decrease in liquidity forces the company to draw upon its credit line. Buyers examine this figure during due diligence for acquisitions in order to assess whether the target company can pay suppliers and employees even during the transition period.

How to improve a low liquidity ratio:

Measures to increase liquid assets or reduce short-term liabilities are equally helpful. Common methods include accelerating the collection of receivables, converting slow-moving inventory into cash or receivables, refinancing short-term debt with long-term debt and maintaining a sufficient cash buffer. The goal planner integrated in the calculation tool converts the desired key figure into concrete numbers. It shows how much liquid funds you need to increase or how much debts you have to reduce to achieve your goal.