Value Investing: What is Quick Ratio?Apr 28, 2021
As I explained in the first article from the series, when we talk about the quick ratio, we will speak of only the most liquid assets, which can turn to cash in 90 days or less (e.g., cash and equivalents, marketable securities, accounts receivable). The concept behind it is the same as that of the current ratio, and this is visible from the mathematical formula (1), which we will use to calculate the quick ratio.
Quick Ratio = Quick Assets / Quick Liabilities (1)
To make it easier to understand, let’s consider the quick ratio as an emergency fund. When you have emergency expenses that need to be paid as soon as possible, you use your emergency fund. The result you seek is a swift solution to your issues. The purpose of the quick ratio is the same: speedy results. With that being said, let’s analyze the data from the table below.
After we analyzed the data from the table above, we can see that after the peak in 2016, there’s a gradual decrease in the quick ratio (the graph below). Looking at the background data, we can see why. Since 2016 the quick assets increased by 19.66%, while the quick liabilities increased by 32.32%. Same as with the current ratio, the growth of the liabilities (mostly long-term debt) outpaced the growth of the assets.
In 2020, things look a bit different. Let’s take a look at the table below.
Unlike the gradual decrease from 2016 to 2019, in 2020 from the quarterly data we can see that the quick ratio has been gradually increasing (the graph below).
As discussed in the current ratio section, I can call this increase a deceiving one. Since this ratio is calculated for the most liquid assets, we can’t evaluate longer-term projections. In the near term (up to 90 days), the calculation shows us that the company owns 0.55 cents of quick assets for each dollar of debt. Despite the number being positive, my outlook would remain negative because of the massive increase in the long-term debt. If you want a swift evaluation and a short-term hold of the stock, this is the ratio to go with. If you decide to hold for longer, I would always consider the current ratio with debt background analysis.
We end the liquidity ratios from our article series with this ratio. In the following article, we will start analyzing the valuation ratios, which are among the most important ratios for buying a stock.
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