quick ratio

Quick ratio

This ratio is slightly more conservative than the current ratio. It is used to check the liquidity position of a company for 1 to 2 months.

This ratio is types of liquidity ratio that measure the liquidity of a company between 1 to 3 months

Formula

Quick ratio is the ratio of quick assets and current liabilities

Quick ratio = Quick assets / Current liabilities

Quick assets

Assets of companies that can be converted into cash within 1 to 3 months, we call it Quick Assets.

Example Reserve cash & bank deposits, Short term investment, Account receivable, Short term is given loan and advances

Quick assets = Reserve cash & bank deposits + Short term investment + Account receivable + Short term loan and advances

you can also find the quick assets by subtracting inventory from current assets

Quick ratio = (Current assets – Inventory) / Current liabilities

If you do not know about the current assets, inventory, account receivable, and current liability, then you can read the post containing part 1 of the liquidity ratio, whose link we have given, please read now

You can find the data of current assets and current liability on the balance sheet of any Indian company on the website https://www.moneycontrol.com/

Example

11– If you are considering Company XYZ as a potential investment, one of the many pieces of information you examine is the liquidity position (between 1 to 3 months) of the company.

  • Cash & bank deposits = 20000
  • Short-term investment = 15000
  • Account receivable = 25000
  • Short-term given loan and advances = 10000
  • Current liabilities = 50000

Quick assets = 20000 + 15000 + 25000 + 10000 = 70000

When we plug the relevant data into the above formula, we get the this ratio of the XYZ company.

Quick ratio = Quick assets (70000) / Current Liabilities (50000) = 1.4

2. We take an an live example of BHEL (Bharat Heavy Electricals Ltd.) date- 23/07/2020

First of all, you have to go to the https://www.moneycotrol.com website, after that you will have to search by entering the name of the company and you will have to click on the option of financial data upwards. you will get an option of a balance sheet as soon as you click. On which you can find current assets and current liability by clicking.

Then go to https://www.indiainfoline.com/ website, after that you will have to search by entering the name of the company and you will have to click on the option of financial data left side. you will get an option of a balance sheet as soon as you click. On which you can find Inventory.

I have found BHEL’s current assets, Inventory, and current liabilities data which you can see below

  • Current assets = 32,711.18
  • Inventory = 8672
  • Current liabilities = 22676.84

According to formula of quick assets = current assets – inventory = 32711.18 – 8672 = 24039.18

Quick ratio = Quick assets / current liabilities = 24039.18 / 22676.84 = 1.06

Analysis

quick ratio analysis

1If the quick ratio of less than 1–  If the quick ratio of a company is less than 1, then that company should avoid because it means that even if this company sells its quick asset, it cannot pay off its short term liability.

  • Quick asset value is less than it’s current liabilities.
  • indicates Short-term trouble for a company.
  • High liquidity risk.

2. If the quick ratio between 1 and 2.5– When the quick ratio of a company is between 1 and 2.5, the company is considered to be in very good condition. Companies of this type indicate to invest money

  • Known as ideal quick ratio
  • The company can easily meet its current liabilities in the very short term.

It is not at all like that for a company whose quick ratio is above 1, we should invest in that company. To invest in a company, we have to check a lot of factories.

3. If the quick ratio is more than 2.5– When the quick ratio of a company is above 2.5, it is not considered to be in a good condition because it means that the company has more cash and the company is not doing its utilities properly.

  • Comfortable to meet its current liabilities
  • Short-term funds not utilized efficiently as funds are either idle or locked up in receivable or bank deposits

Remark

On the top side, we have found the quick ratio of the XYZ company and BHEL, now we analyze both the companies

  • The quick ratio of XYZ is 1.4 which is a good sign for a company and we must do research to invest in these types of companies.
  • BHEL’s quick ratio is around 1.06 which is a good sign for a company and we must keep a watch to invest in companies of this type

In the next post we will talk about the cash ratio

Thank you for reading our post, God bless you all

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