Like the current ratio, the quick ratio is also used to assess the ability of a company to meet its payment obligations that will due within a period of 1 year but with a difference. This ratio is also called the acid test ratio.
Calculation of Quick Ratio
This ratio is calculated by using the formula Current Assets (excluding inventories) รท Current Liabilities.
Composition of Current Assets
Cash and bank balances, marketable investments, sundry debtors/book debts/accounts receivable/trade debtors, bills receivable, stores & spares, prepaid expenses and advances recoverable within a period of 1 year are treated as current assets. Inventories comprising stocks of raw materials/work in process/finished goods, etc. are excluded.
Current Liabilities
Current liabilities include cash credit/overdraft/export credit from banks, sundry/trade creditors, bills payable, instalments of debts payable within a period of 1 year, outstanding expenses payable and provisions for expenses.
Rationale
Inventories are excluded from current assets as these are least likely to be converted into cash within a period of 1 year considering the production period, holding period, and credit period offered to buyers. Current liabilities are identical for computation of current ratio and quick ratio. The rational is that payment of liabilities is inevitable.
Conclusion
A quick ratio of 1 is regarded as satisfactory. It means that the enterprise has a rupee worth of assets that can be quickly converted into cash for every rupee of liability.
