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The Quick Ratio, also known as the Acid-Test Ratio, is a financial metric used to measure a company’s short-term liquidity position. It evaluates the ability of a business to cover its current liabilities using its most liquid assets — assets that can quickly be converted into cash, such as cash itself, marketable securities, and accounts receivable. Unlike the current ratio, the quick ratio excludes inventory from current assets because inventory may not be easily converted to cash in a short period. In this video, we’ll explain how to calculate the quick ratio step by step with a simple example.

1. Identify the Formula for Quick Ratio:
The quick ratio formula is:
Quick Ratio = (Current Assets – Inventory – Prepaid Expenses) ÷ Current Liabilities.
This formula focuses on assets that can be quickly turned into cash to meet short-term debts.

2. List All Current Assets:
Begin by identifying a company’s current assets, which typically include cash, marketable securities, accounts receivable, inventory, and prepaid expenses as recorded on the balance sheet.

3. Exclude Inventory and Prepaid Expenses:
Since inventory and prepaid expenses are not easily converted into cash within a short time frame, subtract these two from the total current assets to focus only on liquid assets.

4. Identify Current Liabilities:
Locate the company’s current liabilities, which are obligations the company must pay within a year, such as accounts payable, short-term loans, salaries payable, and accrued expenses.

5. Plug Values into the Formula:
Substitute the figures for current assets (excluding inventory and prepaid expenses) and current liabilities into the quick ratio formula to calculate the final result.

6. Example of Quick Ratio Calculation:
Imagine a company has $50,000 in current assets, including $10,000 in inventory and $5,000 in prepaid expenses, and $25,000 in current liabilities.
Quick Assets = $50,000 – $10,000 – $5,000 = $35,000.
Quick Ratio = $35,000 ÷ $25,000 = 1.4.

7. Interpret the Result:
A quick ratio of 1.4 means the company has $1.40 in liquid assets for every $1.00 of current liabilities, suggesting it is in a strong position to cover its short-term obligations without relying on selling inventory.

8. Compare Against Industry Standards:
After calculating the quick ratio, compare it with industry benchmarks or competitors to evaluate whether the company’s liquidity position is favorable or needs improvement.

9. Recognize the Limitations:
Remember that while the quick ratio provides valuable insight into short-term liquidity, it does not account for the timing of cash inflows and outflows or long-term financial health.

10. Use Alongside Other Financial Ratios:
For a complete analysis, combine the quick ratio with other financial ratios like the current ratio, debt-to-equity ratio, and gross profit margin to get a well-rounded view of a company’s financial standing.