The concept of quick ratio is used in accounting to indicate the short-term liquidity of any company.
It is used to measure the capacity of the company to pay off its obligations by utilizing the maximum number of its liquid assets, and because of this reason, the quick ratio of any company does not include the inventories or the current assets. The formula that is used to derive the quick ratio is mentioned below:
Quick Ratio = (current asset – inventory)/current liabilities.
Understanding the Concept of Quick Ratio in Detail
The quick ratio is considered to be more conservative as compared to the current ratio mainly because it does not take into account the inventory as well as the current assets of any company.
Hence the major factor to derive the quick ratio is based on the assumption that cash and all types of marketable securities are the only immediate sources of procuring money.
The reason it excludes inventories is that stocks of any company can take a lot of time to be transformed into capital and if the owners wish to sell it as soon as possible then they might incur a lot of loss instead of any profit.
However, there is a lot of debate on the idea that whether the account receivables should be placed under the category of making cash depends mainly on the credit term that is extended to the customer by the company.
Therefore, if a company gives less time to its debtors to pay off the obligations are in a much better position of getting their money back as compared to the businesses that offer an extended period. The reason for this is that you never know how the financial condition of your creditor changes in the long-term.
Another reason is that the account receivables for any company can be less than the book value of any business mainly because of the discounts or credit losses.