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Reasons Quick Ratio Is Important To Investors.

Quick Ratio



What do investors look out for when assessing a potential investment opportunity in a company?


When investors consider a business to invest in, they are mostly interested in the profitability of that business.


But they are also interested in the solvency , efficiency and capital structure of the business.


Why would investors be interested in the solvency or liquidity of a business they desire to invest in?


Because it’s important to know if the business under consideration would have the financial capacity to meet its current maturing liabilities. It’s worthy of note that businesses carry out transactions on both credit and cash bases.


The quick ratio (or acid test ratio) is used to test the solvency or liquidity of a business through the ratio analysis of its financial statements.


What is quick ratio or acid test ratio?


The quick ratio is a solvency test that compares the total current assets of a business excluding stock, to its total current liabilities.


The goal of quick ratio is to determine whether a business has sufficient short-term assets (current assets easily convertible to cash) excluding stock, to meet short-term liabilities (current liabilities).


Why is stock excluded in the acid test ratio?


Stock is excluded because it is considered to depend on current and future market forces which may make it almost impossible to convert to cash in the short term. So, stock is deemed to be relatively illiquid


What are current assets and current liabilities?


Current assets or short term assets are assets a business owns, applies to the smooth running of its operations, replaces when necessary and easily converts to cash within a period usually less than or equal to twelve months.


Current liabilities are a business's debts that are usually due for payment to creditors within a period of less than or equal to twelve months.


What is the formula for calculating quick ratio?


Quick ratio is calculated by (Current assets Less Stock)/Current liabilities.


What is a good quick ratio?


A good quick ratio is a 1:1. 


This means that the total current assets (omitting stock) of the business is equal to the total current liabilities.


This article first appeared on Ayi Post.




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