What is the quick ratio and how do you calculate it?

Projections and forecasts are powerful cash flow tools, but sometimes you need to answer a more pressing financial question: can I cover my short-term costs?

The quick ratio is a key financial metric for evaluating your business' short-term liquidity. It shows whether you can cover your debts (bills, loan repayments) for the next three months. You may have heard it called an acid test ratio, too.

In this guide, we answer the question ‘What is a quick ratio?’ and show you how to calculate quick ratios for your business. Keep reading to learn more about this cash flow management tool.

Understanding the quick ratio: Definition and importance

Businesses need cash. So having liquidity in your business – that’s how quickly and easily you can turn an asset into cash – is crucial.

You can use the quick ratio to assess your finances. It indicates how well you can cover your debts for the next three months by showing how much cash (or cash equivalents) you have available. Combined with other exercises like cash flow forecasts and projections, quick ratios can help make sure you’re operating in the black.

It’s a more cautious view of liquidity because you don’t include prepaid expenses and inventory as cash equivalents. You might purchase stock that stays in your inventory for months on end – which makes it less liquid than cash or cash equivalents.

What does the quick ratio show?

The quick ratio is best used for short-term analysis – checking to see if you can cover upcoming expenses, and deciding if it’s a good time to purchase more equipment or stock. It’s a useful measure of short-term business viability, and the simple formula means you can easily work out your own quick ratio.

Other liquidity ratios include the current ratio and cash ratio. The current ratio includes inventory and gives you a 12-month view. The cash ratio focuses solely on cash and cash equivalents but doesn’t include accounts receivable.

Completing a quick ratio calculation every month or quarter could help you with cash flow management because it gives you more visibility on your financial position.

Quick ratio versus current ratio: Understanding the differences

Current ratios provide a longer-term view than quick ratios. The current ratio formula differs too: you divide your current assets (cash and stuff that can be sold quickly) by your current liabilities (money owed during the next 12 months).

A key difference between current ratio and quick ratio is that the former includes inventory, so it’s a less restrictive view of available cash. All the information you need to calculate current ratios can be found on your balance sheet.

For both the current ratio and quick ratio: the higher the ratio, the more money you have to cover your costs. We share more tips in our guide on the current ratio.

How to calculate the quick ratio

Let's take a look at how to complete a quick ratio calculation.

Quick ratio formula and calculation steps

There are two ways to calculate the quick ratio:

Both formulas use numbers from across your business finances, and you can find these on your balance sheet. If you’re using modern accounting software, you should be able to pull up your balance sheet in a few clicks. Otherwise, you can use our balance sheet template to get started.

Examples of quick ratio calculations

Nina runs a stationery shop. Sales are steady, but she has a few large payments on the horizon for remodelling and redecorating. She decides to calculate her business’ quick ratio to make sure she can cover upcoming bills.

Nina uses the following quick ratio formula:

• Cash + marketable securities (financial assets that can easily be bought and sold, like stocks) + accounts receivable (money owed to you) / current liabilities (money your business owes) = quick ratio.

Nina has £10,000 in cash and no marketable securities like stocks or bonds. She does have an outstanding invoice of £750 due from a corporate customer. This means she has £10,750 in liquid assets.

In terms of current liabilities, Nina owes £5,000 for the remodel of her shop, and £2,500 for painting and decorating. That’s a total of £7,500 for current liabilities.

The calculation for Nina’s quick ratio is: £10,750 / £7,500 = 1.4

Because Nina’s quick ratio is higher than 1.0, she could cover the bills for remodelling and redecorating.

Let’s look at one more example using the other quick ratio formula.

Oman owns a clothing store. Things are going well, but he wants to check the financial impact of a new till and Point of Sale (POS) system that he purchased this week.

Oman uses the following quick ratio formula:

• Current assets (cash, cash equivalents, accounts receivable) - inventory and prepaid expenses / current liabilities = quick ratio

Oman has £15,000 in cash (current assets) and no cash equivalents or accounts receivable. But, according to his balance sheet, he does have £8,000 worth of inventory.

Oman’s current liabilities include things like payroll, supplier invoices, and some interest owed. This comes to £5,000. The new till and Point of Sale (POS) system cost £2,000.

The quick ratio calculation for Oman’s business is £15,000 - £8,000 (£7,000) / £5,000 + £2,000 (£7,000) = 1.0

Oman’s quick ratio of 1.0 means he could cover the costs included in this calculation. If his quick ratio were to drop below 1.0, he might struggle to pay his bills. Improving his quick ratio would mean he has more cash available should unexpected expenses crop up.

Analysing quick ratio results

A quick ratio above 1.0 should mean you have the cash to cover upcoming debts – but some businesses will find it easier than others to maintain a higher ratio.

Industry and business type can impact your quick ratio, meaning it’s best to compare your quick ratio to businesses like yours. Retail stores often have cash tied up in stock, which means they have less liquidity. So when it comes to calculating their quick ratio, a larger portion of inventory needs to be deducted compared to other business types (say, service industries).

If your quick ratio dips below 1.0, you might need to generate more cash or cut back expenses. Having cash available for the ups and downs of your business is essential – a healthy quick ratio ensures debts don’t go unpaid.

But remember: the quick ratio is just a snapshot of your business’ financial picture. Using this calculation in combination with cash flow forecasts, profit and loss sheets, and other financial tools will always be more helpful than using it in isolation.

Quick ratios can change suddenly if you make a hefty purchase or receive an influx of cash. But this doesn’t necessarily represent how healthy your business finances are. Take quick ratios with a pinch of salt, and track them over time for a more reliable quick ratio analysis.

What is an ideal quick ratio?

An ideal quick ratio will be above 1.0 – this means you can cover your costs. But certain business types including retail and seasonal may struggle to maintain a steady quick ratio above 1.0. This doesn’t mean these businesses are performing poorly, it just means they might need different analysis tools to get a clearer picture.

Liquidity fluctuates. You might have periods where there’s plenty of free cash because you’re yet to hire new staff, or your accounts receivable are full of unpaid invoices. Other times, you might be strapped for cash after opening a new office – a sign that you’re growing.

Along with calculating your quick ratio, generating cash flow statements, forecasts, and projections can help with cash flow management. These show income and expenditure from a variety of sources – operations, investments, and financing.

Using Xero to monitor, analyse, and improve your quick ratio

Improving your quick ratio is about making sure you have ample cash to cover short-term debts. Perhaps you can cut inventory levels to keep more cash available. Or you might need to double down on sales if cutting inventory or expenses isn't feasible. It’s all about finding balance in your business.

With Xero accounting software, getting a complete picture of your finances is simple. Pull up balance sheets in a few clicks and access the numbers you need to complete a quick ratio calculation. Xero features use live data from your bookkeeping records, so as long as your reconciliations are up to date, the numbers on your balance sheet will be too.

And there are plenty of other tools to support your healthy cash flow. From a live dashboard that shows your current financial position, to cash flow forecast and projection reports, you can quickly get clear on your finances.

The value of monitoring your quick ratio

Knowing your quick ratio will help you plan ahead for upcoming debts. And even if your quick ratio isn’t as high as you’d like – you have a greater awareness of what may need to change in your business operations.

Regularly monitoring your quick ratio is just one of the tools you should have in your cash flow arsenal. Using accounting software like Xero gives you access to current, reliable data, which you can use to discover financial insights about your business.

For more on managing your finances, check out our cash flow tips for small businesses.