Financial ratios should be compared with industry standards to determine whether such ratios are normal or deviate materially from what is expected. While a high Quick Ratio indicates quick liquidity ratio strong liquidity, it may also suggest that the company is not efficiently using its assets. It’s essential to consider industry norms and the company’s specific circumstances.

• As the quick ratio only wants to reflect the cash that could be on hand, the formula should not include any receivables a company does not expect to receive.
• Although solvency does not relate directly to liquidity, liquidity ratios present a preliminary expectation regarding a company’s solvency.
• Given the structure of the ratio, with assets on top and liabilities on the bottom, ratios above 1.0 are sought after.
• However, the quick ratio is the more conservative measure of the two because it only includes the most-liquid assets in the calculation.

A company’s current ratio will often be higher than its quick ratio, as companies often use capital to invest in inventory or prepaid assets. For example, a ratio of 2.0 means that the company has $2 on hand for every $1 it owes. This is generally good, as it means that the company can easily make payments on any of its debts. However, https://www.bookstime.com/articles/customer-invoice an excessively high quick ratio might, in some cases, indicate that the company may not be using its money wisely, choosing to hold onto cash that it could otherwise reinvest in the business. The acid test of finance shows how well a company can quickly convert its assets into cash in order to pay off its current liabilities.

Types of Financial Ratios

Sometimes company financial statements don’t give a breakdown of quick assets on the balance sheet. In this case, you can still calculate the quick ratio even if some of the quick asset totals are unknown. Simply subtract inventory and any current prepaid assets from the current asset total for the numerator. In the example above, the quick ratio of 1.19 shows that GHI Company has enough current assets to cover its current liabilities.

A company with a high quick ratio can meet its current obligations and still have some liquid assets remaining. The quick ratio, also known as acid-test ratio, is a financial ratio that measures liquidity using the more liquid types of current assets. Its computation is similar to that of the current ratio, only that inventories and prepayments are excluded. While the high inventory balance and growth benefit the current ratio, the quick ratio excludes illiquid current assets such as inventory.