Quick Ratio

Quick Ratio (aka ‘acid test’) is in some way a slight improvement over the current ratio, because the former takes inventory and other less liquid assets out of you current assets. What remains is cash, marketable securities and accounts receivable.

Quick Ratio theoretically determines whether a firm has enough short-term assets to cover its immediate liabilities without selling your inventory (which might be a major hassle, disruptive to your operations and may require a steep discount to the book value of your inventory).

However, even Quick Ratio is far from perfect. First, you still have you’re A/R. Which can be a major pain in you-know-where. Unless you decide to sell it to a third party (this is called ‘factoring’). Naturally, at a significant discount that depends squarely on the quality of you A/R. In terms of their probability of being paid on time and in full.

On average, discount rates for invoice factoring fall between 2 and 7% of the value of the receivables factored.  A typical 30-day invoice will be discounted 2 to 4%.  The fee for an invoice that has aged 60 days would be 4-7%.

Second, you can sell your inventory; that fact that Quick Ratio totally ignores. Therefore, it is still better to use Current Ratio as your primary liquidity measure but make the abovementioned ‘cash conversion adjustments’.

In reality your liquidity ratios are a part of your risk management system. They refer to a risk of all your current liabilities coming due at the same time and in full. Which rarely happens (other than in a terminal case of corporate liquidation). Therefore, you must describe several realistic liquidity scenarios and make sure that you know exactly how to meet your obligations under each one.