Quick Ratio

The Quick Ratio is a more conservative test of a company's liquidity, than the Current Ratio. We have learnt that a current ratio of 1.5 or more means the firm should be able to meet operating needs without much trouble. Unfortunately, some current assets - such as inventories - may be worth less than their value on the balance sheet. (Imagine trying to sell old PCs or last year's fashions to generate cash - you would be unlikely to receive anything close to what you paid for them.) Current assets less inventories, divided by liabilities equals Quick Ratio.

Quick Ratio =(Current assets - Inventories)/Liabilities

In the event that short-term obligations need to be paid off immediately, there are situations in which the current ratio would overestimate a company's short-term financial strength. By taking inventories out of the equation, Quick Ratio lets us find out if a company has sufficient liquid assets to meet its short-term operating needs. It is especially useful for manufacturing firms and for retailers because both of these types of firms tend to have a lot of their cash tied up in inventories.

Rough benchmarks for analysing a stock's
Quick Ratio