What is quick ratio?

The quick ratio, or “acid test,” is a financial metric that measures your business’s liquidity—your ability to meet short-term obligations using only your most liquid assets.

This ratio reflects your business’s capacity to cover expenses, pay employees, and make necessary investments without delay.

The quick ratio focuses on assets that can be converted to cash quickly, such as cash reserves and receivables, and shows your company’s financial flexibility and resilience.

Usually, for your business:

• a higher ratio signals greater liquidity and a stronger position to handle your immediate commitments,
• a lower ratio could indicate that you have limited flexibility for meeting short-term obligations

Immediate financial commitments/obligations could include expanding product lines, hiring talent, or managing customer acquisition costs.

Here’s what we’ll cover

How to calculate the quick ratio

Formula

Quick ratio = (current assets – inventory) / current liabilities

Here’s how it breaks down:

• Current assets: assets that can be turned into cash within a year, like cash, accounts receivable, and marketable securities.
• Inventory: excluded from the quick ratio as it may take time to sell; for example, unsold stock in a retail store.
• Current liabilities: short-term obligations due within a year, such as supplier bills, wages, or short-term loans.

Example

Your company has $500,000 in current assets, $100,000 in inventory, and $200,000 in current liabilities.

Subtract inventory from current assets: $500,000 – $100,000 = $400,000.

Divide by current liabilities to get the quick ratio: $400,000 / $200,000 = 2.0.

A quick ratio of 2.0 shows that your company has twice as many liquid assets as needed to cover its short-term liabilities.

What does the quick ratio tell you?

Generally, a quick ratio above 1.0 suggests that your company can comfortably meet its immediate obligations.

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CFO tip: recognize red flags

A sudden drop in your quick ratio could signal delayed payments or cash flow issues. Review your accounts receivable regularly and watch for patterns of late payments from key clients.

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What is a good quick ratio?

The ideal quick ratio could vary by industry. For example, if your industry average is 3.0, a ratio of 2.0 might indicate relatively weaker liquidity

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CFO tip: improve your quick ratio

Reducing unnecessary expenses, deferring non-essential capital expenditures and renegotiating supplier terms can quickly boost your quick ratio by keeping liquid assets readily available.

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Possible industry applications of the quick ratio

Manufacturing and retail

High inventory levels can slow liquidity, making the quick ratio a valuable tool to focus on truly liquid assets.

• A ratio above 1.5 can help cover short-term obligations despite delayed cash inflows.

SaaS

With minimal inventory, SaaS companies can rely on accounts receivable and cash reserves as primary liquid assets.

• A ratio of around 1.0 generally covers liabilities and frees up funds for growth initiatives.

Financial services

Liquidity is crucial for financial institutions to meet sudden cash demands during market volatility.

• A ratio above 1.0 ensures resilience, allowing coverage of short-term liabilities without disrupting investments.

Professional services

Professional services firms rely on accounts receivable rather than inventory.

• A ratio around 1.0 is typically sufficient to cover expenses, maintaining cash flow for payroll and operational needs.

Healthcare

Healthcare providers face cash flow delays due to insurance reimbursements and fluctuating patient volumes.

• A ratio above 1.0 supports financial stability, enabling coverage of immediate costs like payroll and medical supplies.

Quick ratio versus current ratio: The key differences

Another term that you may encounter could be the current ratio.

	Quick ratio	Current ratio
Definition	Measures your company’s ability to cover immediate obligations using the most liquid assets, excluding inventory.	Measures your company’s ability to cover short-term obligations using all current assets, including inventory.
Formula	(Current assets – Inventory) / current liabilities	Current assets / current liabilities
Best use case	For industries where inventory is not easily converted to cash, e.g., manufacturing.	For industries where inventory turnover is high, e.g., retail.

The quick ratio is a conservative measure of liquidity

• The quick ratio focuses on your company’s ability to meet short-term obligations using only your most liquid assets, excluding inventory.
• This conservative approach is excellent for assessing liquidity when your inventory cannot quickly convert to cash (like manufacturing or retail). It is a reliable indicator for industries where rapid access to cash is essential.

The current ratio is a broader view of assets

• The current ratio, calculated as current assets / current liabilities, includes all current assets, like cash, receivables, and inventory.
• In inventory-heavy industries like retail or manufacturing, your current ratio may appear strong even when a significant portion of assets is tied up in stock.

What a difference between quick and current ratios could mean

• If you have high inventory levels, a high current ratio but a lower quick ratio can indicate potential liquidity risks if inventory takes time to sell.
• If inventory turnover slows, a lower quick ratio signals potential cash flow issues. In contrast, a just-in-time inventory model or reduced stock levels can improve cash flow and align these ratios more closely.

When the quick and current ratios are the same

• When the quick and current ratios are equal, it usually indicates minimal or no inventory—common in-service industries like SaaS, where assets are liquid.
• This alignment often reflects efficient financial management, high liquidity, and an asset structure that supports swift responses to opportunities, which investors and creditors like.

Cash ratio versus quick ratio

The cash ratio measures your company’s ability to cover short-term obligations using only cash and cash equivalents. Unlike the quick ratio, it excludes accounts receivable.

Formula

Cash ratio = (cash + cash equivalents) / current liabilities

When to use

The cash ratio is ideal for assessing immediate liquidity without assuming future collections, but it may be too conservative for businesses that collect payments reliably, like SaaS or professional services.

Practical applications of the quick ratio in business

The quick ratio is invaluable for creditors, investors, and executives like CFOs.

Creditors use it to gauge a company’s ability to repay loans, while investors gain insights into its short-term financial stability.

Internally, you can use the quick ratio to assess liquidity, plan future expenditures, and identify opportunities to enhance cash flow.

Here’s an example.

Imagine a mid-sized manufacturing firm.

• You review the quarterly financials and notice a dip in the quick ratio from 1.8 to 1.2.
• Recognizing this as a potential liquidity concern, you investigate further and find that increased accounts payable have temporarily strained your cash flow, although sales are steady.
• To counter this, you postpone some non-essential capital expenditures, freeing up liquid assets to improve the quick ratio.

Here’s how your numbers might look.

1. Previous quarter quick ratio calculation (1.8):

• Current assets (excluding inventory): $180,000
• Current liabilities: $100,000
• Quick ratio = 180,000/100,000 = 1.8

2. Current quarter quick ratio calculation (1.2):

• Due to an increase in accounts payable, current liabilities have risen to $150,000, while current assets (excluding inventory) remain stable at $180,000.
• Quick ratio = 180,000/150,000 = 1.2

3. Your action and impact

• To improve liquidity, you defer $30,000 in non-essential capital expenditure, increasing current assets (excluding inventory) to $210,000.
• The revised quick ratio = 210,000/150,000 = 1.4

Through this proactive measure, you effectively improve your firm’s quick ratio from 1.2 to 1.4, strengthening your short-term liquidity position and mitigating potential financial strain.

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CFO tip: Set a quick ratio target

Establish a quick ratio benchmark for your business and track it monthly.
For example, set a target ratio of 1.2 or higher to comfortably meet short-term liabilities without relying on slower-moving assets like inventory.

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The power of the quick ratio in financial analysis

Traditionally, calculating the quick ratio was a manual process, where finance teams would pull data from various sources, including balance sheets and accounts, to gather current assets and liabilities.

While the formula is straightforward, the time and effort needed to obtain and verify accurate figures to plug in were often substantial.

This slow, manual approach could lead to outdated insights, making relying on the quick ratio for real-time financial decision-making challenging.

How tech can boost your quick ratio analysis

Modern financial technology (such as Sage Intacct) boosts the speed and accuracy of quick ratio analysis, supporting agile financial management.

You could benefit from:

• Real-time insight: automated tools reduce errors and offer up-to-date insights, helping you make immediate decisions.
• Integrated data: cloud-based platforms can centralize financial data, making metrics like the quick ratio accessible and reliable.
• Custom dashboards and alerts: track ratios over time and receive alerts for significant changes, allowing proactive liquidity management.

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CFO tip: Stay on top of accounts receivable

To maintain a healthy quick ratio, streamline your accounts receivable process with regular follow-ups and early payment incentives to keep liquidity strong.

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Final thoughts

The quick ratio is a strategic tool that offers insight into your company’s liquidity and financial readiness.

Regular monitoring gives you time to adjust spending, defer expenses, or focus on collections as needed.

Set a quick ratio benchmark that aligns with industry standards to ensure your business is well-positioned for stability and growth.

Editor’s note: This article was originally published in September 2023 and has been updated for relevancy.