Quick Ratio
Imagine yourself in a situation where you invest your money in a company but unfortunately the company undergoes collapse and all of a sudden you lose your money. In such a condition, the only source for recovery of your money will be those funds which you will get after the liquidation of the company and that also if and only if some money is left for the share holders after liquidizing the company.
What would you do to get on the safer side? Before investing into some company you need to be sure about the money and assets of the company which could recover your money after liquidizing the company. Now, how would you know the liquidity of the company? The simple answer to the question is that quantity which is responsible for measuring the liquidity of the company i.e., Quick Ratio.
Quick Ratio is used for signifying the liquidity of the company. The ratio is basically determined by summing the current assets and accounts receivable and this sum is then divided current liabilities. Inventory is specifically excluded in this method. Generally, if a company is having its quick ratio 1 or higher then it is considered healthy for the company and it signifies that the sale of inventory is required by the company to pay off the bills. Quick ratio less than 1shows that the company might get into trouble anytime and the new investors should maintain some distance from the company.
The quick ratio is calculated by dividing the sum of accounts receivable, cash equivalents and cash & the sum of accruals, accounts payable and notes payable. However, some situations may arise when quick ratio cannot give the liquidity of the company efficiently. You may mislead by the picture shown by the quick ratio. For instance, assume a company having no due bills for today but having many bills for tomorrow. The quick ratio calculated for such a company for the present day will signify towards good liquidity. But, actually this company does not has good liquidity.
Written by: Matt
We also suggest this relevant article if you have time: Expectancy Theory by Victor Vroom
Some other similar articles
Tagged as accounts receivable, accruals, amp, cash equivalents, collapse, current assets, current liabilities, due bills, investors, liquidation, liquidity, money, present day, quick ratio, safer side, share holders, simple answer + Categorized as Economy articles, Finance