Quick Ratio

The quick ratio, also known as the acid test, serves a function that is quite similar to that of the current ratio. The difference between the two is that the quick ratio subtracts inventory from current assets and compares the resulting figure (also called the quick current assets) to current liabilities.

Why? Inventory can be turned to cash only through sales, so the quick ratio gives you a better picture of your ability to meet your short-term obligations, regardless of your sales levels. Over time, a stable current ratio with a declining quick ratio may indicate that you've built up too much inventory.

If your quick current assets are $90,000 and your current liabilities are $30,000, your acid test ratio would be 3:1 (90,000:30,000).

How to improve your quick ratio. Since this ratio is quite similar to the current ratio, but excludes inventory from current assets, it can be improved through many of the same actions that would improve the current ratio. Converting inventory to cash or accounts receivable also improves this ratio.

In evaluating the current ratio and the quick ratio, you should keep in mind that they give only a general picture of your business's ability to meet short-term obligations. They are not an indication of whether each specific obligation can be paid when due. To determine payment probability, you may want to construct a cash flow budget.

In general, a quick or acid-test ratio of at least 1:1 is good. That signals that your quick current assets can cover your current liabilities.