Total
Current Liabilities
The quick
ratio or “acid test” is a more conservative measure of liquidity than the
current ratio. The numerator includes
only the most liquid assets, and it excludes inventory and other accounts such
as prepaid expenses.
Some
accounting and finance experts simply present the quick ratio numerator as
“Current Assets minus Inventory.” This
is the most basic way to calculate the quick ratio. The quick ratio presented here is actually
more conservative, since its assets include only cash, cash equivalents, and
accounts and notes receivable due within a year.
A quick ratio
below one implies that the business will be dependent upon turning its
inventory to service short-term debts.
This may be problematic for a business that is susceptible to seasonal
or cyclical fluctuations, a manufacturer with significant unfinished goods, or
any business holding obsolete inventory.
If inventory is an issue for a business, then you may study their
inventory and accounts receivable turnover ratios to learn more about their
ability to turn inventory into cash.
For Smith
Heating and Cooling, Inc., their quick ratio is 0.43 versus a current ratio of
1.12. It appears that the company will,
indeed, be dependent upon inventory turnover to service its short-term
obligations. For this reason, it will be
important to carefully study the quality of the company’s inventory as well as
their turnover ratios to perform a complete financial analysis.
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