25 Need-To-Know Management Ratios by Ciaran Walsh & Stuart Warner

Author:Ciaran Walsh & Stuart Warner
Language: eng
Format: epub
Tags: Business, Business Communication, Project Management
ISBN: 9781292016429
Publisher: FT Publishing International

Quick ratio

The calculation here is very similar to that of the ‘current ratio’. Simply remove the ‘inventories’ value from the ‘current assets’ and divide the result by the ‘current liabilities’ total.

The reason for excluding the inventory figure is that its liquidity can be a problem. You will recall that the term ‘liquidity’ is used to express how quickly, and to what percentage of its book value, an asset can be converted into cash if the need were to arise.

For instance, a cargo of crude oil in port at Rotterdam has a high liquidity value, whereas rolls of material for making fashion garments stored in a warehouse probably have a low liquidity value.

We can meet with a situation where a company has a constant current but a falling quick ratio. This would be a most dangerous sign. It tells us that inventory is building up at the expense of receivables and cash.

Lending institutions have difficulty in ascertaining the liquidity of many types of inventory. They feel much more comfortable when dealing with receivables and cash. Accordingly they pay quite a lot of attention to the ‘quick ratio’.

Both the current and quick ratios are the most widely used measures of short-term liquidity but a problem with them is that they are static. They reflect values at a point in time only, i.e. at the balance sheet date. It is possible to ‘window dress’ a company’s accounts so that it looks good on this one day only. To deal with this shortcoming it is argued that cash flow over the short-term future would be a better indicator of ability to pay. The ‘working capital to sales’ ratio covered next meets this objection to a certain extent.

In Figure 8.2 we can see that the quick ratio for the Example Co. plc is 0.8 times.

Figure 8.2 Quick ratio applied to data from the Example Co. plc

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