Here are the latest changes to Berkshire Hathaway’s portfolio and Buffett’s top bets.
Heard of the quick ratio but not sure what it means? Bankrate explains.
What is the quick ratio?
The quick ratio, also known as the acid-test ratio, measures the ability of a company to pay all of its outstanding liabilities when they come due with only assets that can be quickly converted to cash. These include cash, cash equivalents, marketable securities, short-term investments, and current account receivables.
The quick ratio is calculated by dividing the sum of cash and cash equivalents, short-term investments, and account receivables by the company’s current liabilities. These highly liquid investments are also called quick assets.
When a company has a quick ratio of less than 1, it has no liquid assets to pay its current liabilities and should be treated with caution. If the quick ratio is much lower than the current ratio, this means that current assets heavily depend on inventories. The quick ratio is more conservative than the current ratio, as it excludes inventories from current assets.
Since most companies use their long-term assets to generate income, selling them off not only seriously hurts the company but also shows potential investors that current operations are not generating enough profits to pay off current liabilities.
When a company has a quick ratio of 1, its quick assets are equal to its current assets. This also indicates that the company can pay off its current debts without selling its long-term assets. If a company has a quick ratio higher than 1, this means that it owns more quick assets than current liabilities.
As the quick ratio increases, so does the company’s liquidity. More assets can be quickly converted into cash, if necessary. This is a good sign for investors and an even better sign for creditors, as it assures them that they will be repaid on time.
However, a very high ratio is not always a good thing. It could mean that cash has accumulated but is stagnant, rather than being reinvested, repaid to investors, or otherwise put to productive use. Some tech companies generate huge revenues and therefore have quick ratios as high as 7 or 8. These companies have drawn criticism from activist investors who prefer that stockholders get a percentage of the revenue.
Looking for the right money market account for your business? Check out Bankrate’s listings of the best money market accounts.
Quick ratio example
A company’s quick ratio can be calculated using its balance sheet. Cogswell Cogs is applying for a loan to expand its operations, and the bank asks for a detailed balance sheet so that it can calculate a quick ratio for the company. Cogswell Cogs’s balance sheet includes the following accounts:
- Cash and equivalents: $15,000
- Accounts receivable: $10,000
- Inventories: $3,000
- Stock investments: $2,000
- Prepaid taxes: $600
- Current liabilities: $20,000
The bank calculates the company’s quick ratio like this:
Cash & equivalents ($15K) + short-term investments ($2K) + accounts receivable ($10K) / current liabilities ($20K) = 1.35
Based on the calculation above, the quick ratio is 1.35. This means that the company can pay off all of its current liabilities with quick assets and still have some quick assets remaining.
More From Bankrate
4 min read May 16, 2022
These standout apps can help get your finances organized and invested.10 min read May 16, 2022
Consider the costs, educational resources and other factors before opening an account.7 min read May 16, 2022
Here’s where to turn when you’re searching for a safe place to stash cash for the short term.9 min read May 16, 2022
These are ten of the top index funds to consider adding to your portfolio this year.11 min read May 16, 2022
You can use time as a huge ally when planning your investments to build wealth in the long run.15 min read May 16, 2022
The inflation protection on I bonds has caused quite a stir among savers, as inflation has skyrocketed.5 min read May 16, 2022
Need to get your stock or ETF trades in before the opening bell? Here’s what to know about pre-market trading.4 min read May 16, 2022
This index says a lot of about the strength of the dollar. Here’s what investors should know.3 min read May 13, 2022