How to Calculate a Quick Ratio Easily
Although it may appear a daunting task at first viewing, calculating a quick ratio is a fairly straightforward process that only requires one equation. However, when confronted with this one huge equation that encompasses numbers from several sources, it is often good to take a step back and explain each term and process individually rather than in a step by step format.
The first step in knowing how to calculate a quick ratio is learning the equation. The equation is this: (cash + marketable securities + accounts receivable) / current liabilities. To make it a bit simpler, this equation is also accurate: (current assets – inventory) / current liabilities. Basically, all currents assets, except for inventory are divided by all current liabilities, which produces the quick ratio. In doing this, the goal is to have enough assets to cover all liabilities, and this formula is a quick way of calculating it.
Current assets are straight cash, marketable securities, accounts receivable, and inventory. Cash on hand is most obviously a liquid asset that could be applied to debts quickly. Marketable securities are almost as good as cash as they can be quickly converted into it with little or no extra cost. Accounts receivable is also seen as a liquid asset because it is money owed to the company by a customer or outside party. This should be able to be collected quickly should the need arise. Inventory, however, is not always as easy to liquefy, and it is therefore discounted in this formula.
Current liabilities can include short-term debts, accounts payable, and other debts and liabilities. Current liabilities usually refer to those which must be repaid in one year and discount the longer-term debts. Short-term debts usually refer to creditors who expect the debts to be repaid quickly. Accounts payable refers to suppliers and employees who have not yet been paid, whether this is a recurring expense or a single payment. Marketing and distributing bills often must be taken into consideration as well as any extra expenses such as income tax.
As an example, a company has $60,000 cash, $10,000 in marketable securities, $40,000 in accounts payable, and $50,000 in inventory as its current assets. Its current liabilities include $30,000 in accounts payable, $20,000 in short-term debts, and another $10,000 in other miscellaneous expenses. The formula would look like this: ($60,000 + $20,000 + $40,000) / ($30,000 + $20,000 + 10,000). Scaled down, it would be: $120,000 / $60,000. This would yield a quick ratio of 2.0, which means the company has twice enough assets than it needs to cover its liabilities.
Once learning how to calculate a quick ratio is accomplished and the terms are explained, the math becomes fairly simple. The equation may appear daunting, but if the numbers are provided, it’s really just a matter of placing them where they belong. Then, after a few simple additions and a division, the company’s financial stability is ready for all to see.