How to calculate the quick ratio

Quick assets are the current assets that are cash already or are close to it:

• Cash, in business.gov.au's broad sense: money on hand, petty cash and what sits in the business's bank accounts. Include every account the business can draw on at the date.
• Accounts receivable: in business.gov.au's glossary, the short-term amounts still owed by customers.
• Any short-term deposit the business can get at without waiting for it to mature.

Inventory stays out because it has to be sold, and often paid for by a customer, before it turns into cash. Prepaid expenses stay out because the business gets the goods or services it paid for, not money back. A stricter version again leaves out receivables too and compares cash alone with current liabilities.

Add the current assets you count as quick, such as cash, collectible customer invoices and readily accessible short-term deposits, then divide by total current liabilities at the same balance sheet date. If you start from total current assets, subtract inventory, prepaid expenses and any other current assets that do not meet that quick-asset test.

Current liabilities must be above zero. They include supplier bills, credit card balances, unpaid wages, overdraft balances and loan instalments due within 12 months.

Counting every current asset, the wholesaler has more than enough to cover its current liabilities. Take the stock away and quick assets cover only part of what falls due, so meeting every current bill relies on stock being sold and paid for in time.

A balance sheet usually shows total current assets rather than quick assets, so the quickest route is to start from that total and take away what doesn't count. Using the wholesaler's figures:

1. Find total current assets. Cash at bank, petty cash, receivables, inventory and prepaid expenses add up to 52,000.00.
2. Take away the current assets that aren't quick. Inventory of 24,500.00 and prepaid expenses of 1,200.00 come to 25,700.00, which leaves quick assets of 26,300.00.
3. Find total current liabilities: 31,400.00. Nothing is taken away from this side. Every current liability stays in the divisor, whichever assets you leave out.
4. Divide quick assets by current liabilities: 26,300.00 divided by 31,400.00 is 0.84, rounded to two decimal places.
5. Check the working against the current ratio. 52,000.00 divided by 31,400.00 is 1.66, which matches the table. The quick ratio can never be the higher of the two, so a result above the current ratio means a figure has slipped.

Accounts receivable is often the largest quick asset, and the least certain. Run an aged list of unpaid customer invoices at the same date and look at how much is overdue.

business.gov.au calls money that is unlikely to come in soon a bad debt. Whether any of the oldest debts should be treated that way is a question for your accountant, but leaving them out of a second calculation shows how much the ratio leans on them.

• Leaving stock in. Some reports show inventory inside the current assets total, and it is easy to divide that total by current liabilities and call it the quick ratio. The sign is a quick ratio that matches the current ratio even though the business holds stock. Subtract inventory and prepayments from the total before dividing.
• Counting a deposit that is locked away. A term deposit that has not yet matured may not be available when bills fall due. Check the maturity date, and leave the deposit out unless the business can get the money without waiting.
• Taking figures from different dates. The aged list of unpaid invoices is run today while the balance sheet is at the month end, so the two don't agree. Run every report at the same date.
• Working from an unreconciled bank balance. business.gov.au's glossary describes a bank reconciliation as a cross-check that the amounts in your cash book match the bank statements. Reconcile each bank account at the balance date before you calculate, and correct any errors the reconciliation finds in the books.
• Missing liabilities. A credit card statement not yet entered, or a supplier bill dated on or before the balance date that arrived after it, leaves current liabilities too low and flatters the ratio. Enter every bill and statement dated on or before the balance date.
• Counting disputed invoices. An invoice the customer has questioned and not paid is not close to cash. Leave disputed amounts out of a second calculation, as with the oldest debts above, and see how far the ratio moves.

The current ratio counts every current asset, while the quick ratio counts only the ones that are cash already or close to it, so the quick ratio always comes out the same as the current ratio or lower. Both divide by the same current liabilities. The current ratio asks whether everything the business expects to turn into cash within a year would cover what it owes in that time. The quick ratio asks how much of that would be covered without selling any stock.

On the current ratio alone the two look identical. The consulting firm holds no stock, so nearly all its current assets are cash and customer invoices: quick assets of 27,000.00 divided by 20,000.00 gives 1.35, and it could meet its current bills from those alone, provided its customers pay in time. The shop's current assets are mostly stock. Its quick assets of 5,000.00 divided by 20,000.00 give 0.25, so cash and receivables would cover a quarter of what falls due, and the rest depends on selling stock in time.

So which should you use? Both. The current ratio gives the broad view, and the quick ratio earns its place wherever stock makes up much of the current assets or sells slowly, because that is where the two part company. For a business that holds no stock and few prepayments, the two figures sit close together and the quick ratio adds little.

Yes. Acid-test ratio is another name for the same calculation, and both names describe a strict test: whether the business could meet its current bills without relying on its stock.

The cash ratio is stricter again. It counts only cash and deposits the business can get at straight away, and leaves receivables out as well. For the wholesaler in the worked example, cash at bank plus petty cash is 6,450.00, and 6,450.00 divided by 31,400.00 gives a cash ratio of about 0.21.

The current, quick and cash ratios are all liquidity ratios: each measures, at a different level of strictness, how much of what falls due could be met from assets that are already cash or close to it. The quick ratio is not an efficiency ratio. Efficiency measures, such as debtor days, look at how long money takes to come in, not at how much cover there is on a given date.

It can't be negative. Every quick asset is a balance of zero or more, so the smallest possible result is zero: a business with no cash, no accessible deposits and nothing owed by customers. If a working shows a negative quick ratio, look first at the bank balances, because an overdrawn account is a liability and belongs with current liabilities. Then check the receivables list for customer accounts in credit, for example after a customer paid twice, and ask your accountant how those should be shown.

It can be more than 1. That means cash, deposits and receivables alone add up to more than current liabilities, as for the consulting firm above. A business with no stock and few prepayments will usually have a quick ratio close to its current ratio, whether that figure is above 1 or below it.

Work out both ratios at the same date. The gap reflects inventory, prepaid expenses and any other current assets left out of the quick ratio, relative to current liabilities. Look at those balances separately before deciding how much of the cover depends on selling stock.

Track both at the end of each month. If the quick ratio falls while the current ratio holds steady, check whether stock, prepayments or other excluded current assets have grown relative to cash and receivables.

No single figure suits every business, so compare the quick ratio with your own records and with when your bills actually fall due:

• Last month and the same month last year. Stock and customer balances can rise and fall with the seasons, so a fall at the same point each year means less than a fall that is new.
• Your debtor days. If the quick ratio holds up only because receivables keep growing, customers may be taking longer to pay, and the cover is less certain than it looks.
• The cash flow forecast for the next few months. It shows whether customer payments are likely to arrive before the larger bills fall due, which the ratio on its own can't tell you.

Lenders make their own assessments. business.gov.au notes that for an unsecured loan, the lender will usually look at the business's financial health to make sure it can repay. What a particular lender asks to see, and any conditions in a loan the business already has, are set by that lender and that agreement, so ask the lender or your accountant rather than aiming at a figure.

Work the ratio out at each month end from the same reports, and keep the balance sheet and the aged list of unpaid invoices with your working. A year of month-end results shows your own seasonal pattern, which makes the next comparison far more useful.

• Collect sooner. business.gov.au's cash flow guidance points to invoicing earlier, revisiting your payment terms and following up late payers.
• Turn slow stock into cash. Selling old or surplus stock is one of business.gov.au's suggestions when debts are mounting.
• Ask for deposits on special orders, one of the ways business.gov.au suggests encouraging upfront or early payment.

Selling slow stock adds to quick assets. Collecting sooner turns one quick asset into another, so the ratio holds steady but more of it is cash in hand. A deposit brings cash in before the order is filled; how it is recorded until then is a question for your accountant. None of them shows when bills fall due, so test the timing against a cash flow forecast first.