When researching accounting processes, you may come across quick ratio. Millions of businesses calculate their respective quick ratio for accounting purposes. Also known as an acid test, quick ratio provides into a business’s cashflow and, thus, its ability to satisfy debt and liabilities. As a business owner, however, you might be wondering what quick ratio means exactly. This post offers an introduction to quick ratio and how it works in accounting.
What Is Quick Ratio?
Quick ratio is a measurement of how easily your business can pay its debt and liabilities. It essentially reflects your business’s liquidity. The greater your business’s liquidity — meaning it can easily convert assets into cash — the higher its quick ratio will be.
How to Calculate Quick Ratio
There are a few different ways to calculate quick ratio. One of the most common formulas involves adding your business’s cash, accounts receivables and other short-term assets, followed by dividing that number by your business’s short-term debt and liabilities. You can perform this quick ratio calculation for any given period. To determine your business’s quick ratio for last year, for example, just perform the aforementioned calculation using last year’s data.
A quick ratio of 1 means your business’s short-term assets and short-term liabilities were equal for the reporting period. A quick ratio of 2, on the other hand, means your business’s short-term assets were twice as much as its short-term liabilities for the reporting period. Any quick ratio below 1 indicates that your business’s short-term assets were less than its short-term liabilities during the reporting period. You should typically strive for a quick ratio of 1 or higher because it symbolizes positive liquidity.
Why Quick Ratio Is Important
Why should you care about your business’s quick ratio? Quick ratio is all about liquidity. And the greater your business’s liquidity, the easier it will be for your business to satisfy short-term debt and liabilities. Nearly all businesses incur debt. Debt is particularly common during the early stages of a new business. Assuming your business is liquid, you can easily convert its short-term assets into cash, which you can then use to pay off your business’s short-term debt and liabilities.
There are other ways to measure your business’s liquidity. Quick ratio is popular among business owners and accountants, though, because of its simplicity. You can calculate using only your business’s short-term assets and its short-term liabilities. A high quick ratio means that your business has more short-term assets than its short-term liabilities.
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