Definition:

The Quick Ratio, also known as the Acid-Test Ratio, is a financial metric used to evaluate a company's ability to meet its short-term liabilities with its most liquid assets, excluding inventory.

Formula:

Quick Ratio = (Current Assets - Inventory) / Current Liabilities

How to use the metric:

The Quick Ratio is used by investors and analysts to assess a company's short-term financial health. A ratio above 1 indicates that the company has more liquid assets than current liabilities, suggesting good liquidity. A ratio below 1 may indicate potential liquidity issues.

Limitations:

The Quick Ratio does not consider the timing of cash flows and may not accurately reflect a company's liquidity if receivables are not quickly convertible to cash. It also excludes inventory, which can be a significant asset for some companies.

Applies to:

The Quick Ratio is particularly useful in industries where inventory turnover is slow or where inventory is not easily liquidated, such as service industries or technology companies.

Doesn't apply to:

Industries with fast-moving inventory, such as retail or manufacturing, may find the Quick Ratio less applicable because inventory is a significant part of their current assets and can often be quickly converted to cash.

Summary:

The Quick Ratio is a key liquidity metric that helps assess a company's ability to cover its short-term liabilities with its most liquid assets. While useful, it has limitations, particularly in industries where inventory plays a major role in liquidity.