Quick Ratio

Quick ratio (Called acid-test ratio)

The quick ratio excludes inventory and prepaid expenses and other current assets (if any) from cash resources.

Exclusion of inventories, prepaid expenses and other current assets (if any) under quick ratio (ACID test ratio) makes it more conservative than current ratio, in fact quick ratio is the best indicative measure of liquidity, because it measures the company’s ability to meet current obligations without the need to liquidate inventory because they are two or three steps away from cash, also prepaid expenses are not actual cash to be collected but rather it is cash paid in advance and would be amortized to expenses.

An Acid-test ratio below one indicates that the company have difficulty meeting short term obligations if inventory does not turnover fast enough.

Obsolete inventory write off would decrease current ratio but acid test ratio would not affected. Also amortization of prepaid expenses to expenses would decrease current ratio but acid test ratio would not affect.

Using LIFO in the periods of rising prices would decrease current ratio and net income but it will not affect quick ratio.