Is Mudalovers a business owner? Or are you currently starting a business? So that the business can run smoothly and not stop due to several factors, companies need to analyze the company’s financial condition.
By knowing the financial condition of the company, it will be easier for Mudalovers to consider decisions for further business continuity such as procuring goods or even recruiting employees.
To be able to measure the financial condition of a company, there are several general variables, one of which is the quick ratio. Quick ratio is an indicator that has the function of knowing the financial condition of the company.
The quick ratio has several advantages for knowing the financial condition of a company, such as being able to show whether the company has current assets and to pay off short-term liabilities or not.
There are also several other advantages and disadvantages of the quick ratio, find out more by reading the material in the mudabicara.com article , let’s learn together Mudalovers!
Understanding Quick Ratio
According to Kasmir, the quick ratio is a ratio that is used to quickly test and provide benefits in showing the ability of a business or company to pay short-term obligations using current assets, without considering the value of inventory or stock.
Meanwhile, Mamduh and Abdul Halim explained that the term quick ratio is a term used to measure a business’s ability to fulfill its obligations in the short term.
This is due to the fact that in calculating the quick ratio, all inventory elements are omitted or not taken into account in determining the company’s ability to pay off its short-term debt. The term quick ratio is also known as the quick ratio or acid test ratio. One of the characteristics of this ratio is that it only takes into account cash and other assets that can be easily converted into cash in the calculation and interpretation.
For example, this calculation does not include inventory because it takes a long time to convert it into cash. This ratio is sometimes referred to as the Acid Test Ratio, but the meaning remains the same.
If the ratio is higher than one, it means the entity’s current assets after deducting inventory are higher than current liabilities. This indicates that the entity can use current assets to pay its current liabilities. In other words, this ratio provides an indication that the entity has a strong financial foundation.
Conversely, if the ratio is lower than one, the entity may not be able to pay off its current liabilities using current assets. It can be said that the entity has an unhealthy financial condition.
In company operations, one of the functions of the quick ratio is as an indicator of short-term liquidity, or as a measure of the company’s ability to fulfill its short-term obligations.
So from the explanation of the definition of the quick ratio, the conclusion is that the quick ratio is used to calculate the amount of company assets that can be used to pay off all of the company’s liabilities. These assets can also be in the form of receivables, inventory, cash or even short-term investments.
As has been explained, the quick ratio is one aspect used to analyze the financial condition of a company. To be able to calculate this quick ratio, a formula and in-depth understanding are needed.
Read Also : What is Western Culture? Definition, Characteristics, and 4 Examples
Quick Ratio Analysis Method
Before continuing to discuss the formula and examples of quick ratio calculations, Mudalovers need to know that there are actually several methods for analyzing quick ratios, what are they?
-
Intracompany Analysis Method
The first method which is quite common is the method carried out by comparing the company’s financial ratios. An example is the value of the quick ratio or QR compared relative to the current ratio or CR.
-
Trend Analysis Method
The second method of quick ratio analysis is trend analysis which is used by looking at a trend in the company’s financial ratio values over a certain period of time. An example is a five year period, namely from 2017 to 2022 or another time period.
By using the quick ratio analysis method, Mudalovers will see the trend of the company’s quick ratio value during that time period, whether the calculation results show an increase, are stable or are actually decreasing.
-
Industry Comparison Method or Industry Comparison
The third method is carried out by finding the value of the average quick ratio in the manufacturing sector.
From this average value you will be able to see what is an indication of good value, a strong liquidity position to be able to guarantee the company’s short-term debt.
Read Also : What is Public Administration? Definition, Nature, Scope, Function, Objectives and Theory
Quick Ratio Calculation Formula and Example
Even though the definition of quick ratio may sound complicated, actually calculating the quick ratio does not require a difficult formula, you know Mudalovers.
The formula used to calculate the quick ratio is quite simple and very easy to understand.
(Current Assets – Inventory or Stock): Current Liabilities
Simple isn’t it? To make it clearer, the following is a description of the quick ratio formula above.
Current assets in the formula are in the form of receivables, advances, cash or other types of current assets belonging to the company. Meanwhile, current liabilities are interest, debt, short-term debt, current taxes, company liabilities and others.
Mudalovers can find data regarding current liabilities in the financial reports.
To more clearly understand how to calculate the quick ratio using the simple formula above, Mudalovers can listen to the example of the calculation quoted from alati.com below.
Company A has a transaction recorded in the financial statements as follows:
| Current assets | Current Liabilities |
| Cash 100 million | Accounts payable 160 million |
| Down Payment 10 million | Accrued expenses 60 million |
| Securities worth 50 million | Short term debt 50 million |
| Accounts Receivable 60 million | Interest debt of 50 million |
| Stock 70 million |
From the example of the amount of data above, the amount of current assets owned by company A is 290 million, while the amount of current liabilities owned by company A reaches 320 million.
In the previous year, company A’s quick ratio was 1.5 percent with an industry average of 1.6. Then the calculation of company A’s quick ratio is as follows.
(Current Assets – Stock) : Current Liabilities, then you will get (290 million – 70 million) : 320 million = 0.69
Because the value of company A’s quick ratio is below 1.0, it means that company A is unable to settle the current liabilities that must be paid as soon as possible.
So it can be concluded that company A is at risk of facing liquidity problems because the management of the company’s liquid assets is treated poorly.
However, please note that this ratio can only be used to measure short-term capabilities and liquidity positions. So the results of these calculations cannot show that company A is experiencing financial problems.
For example, company A turns out to have a fairly large level of product sales and will get quite high income over a certain period of time.
When the proceeds from the sale of company A are received and the total current assets appear to be able to pay off its current liabilities well, this means that the financial condition of company A can be said to be quite conducive even though it has a low quick ratio.
Quick ratio can be used if a company needs fast detection. Because the calculation of the quick ratio uses an easy formula. But apart from using the quick ratio, there are seven other types of financial risk analysis.
Even though it only presents short-term liquidity position results, this quick ratio can be a benchmark for the company’s financial condition. The quick ratio is also considered very effective in knowing the position and condition of a company’s liquidity from one period to another.
Good financial health can be seen from the ideal quick ratio value, namely 1, or often written as 1:1. If the quick ratio is at that number, it is considered profitable for the company.
On the other hand, if the quick ratio value is below 1, it means that the company does not have adequate liquidity as expected, in other words, the company is considered unable to fulfill its obligations in paying short-term debt.
However, if the value actually exceeds 1, it shows that the company has the ability to fulfill its obligations. However, this also indicates that the company is not optimizing the efficient use of its assets.
What if the quick ratio value shows a number more than 2.5? In this case, it indicates that the company has excellent capabilities to fulfill its various obligations easily.
However, on the contrary, it can also be an indication that the company is not using its short-term funds with optimal efficiency.
Read Also : What is Office Administration? Definition, Function, Goals and Duties
Advantages and Disadvantages of Quick Ratio
As explained at the beginning of the article, this quick ratio analysis has advantages and disadvantages that companies can get. One of the advantages of the quick ratio is that you can find out the value of assets quickly.
Then, there are also several other advantages that are taken into consideration. Quick ratio analysis is often used to determine asset liquidity and there are also several disadvantages of this analysis.
-
Advantages of Quick Ratio
-
Can find out the value of liquid assets
In quickly identifying the value of liquid assets, the quick ratio has the main advantage compared to other liquidity ratios, especially the current ratio. This ratio helps measure the extent to which current assets are able to pay current liabilities more accurately.
The quick ratio calculation involves using only the most liquid assets, which can be quickly converted into cash or are even already in the form of cash.
In other words, these assets can be very quickly converted into cash when current liabilities need to be paid off.
-
Help stakeholders to assess liquidity
Quick ratio helps stakeholders in assessing liquidity. As mentioned previously, this ratio does not include inventory in its calculations.
As is known, inventory can take a long time to convert into cash. This depends on the type of business and the market in which the entity operates.
Some inventory can be converted into cash within a day, while others take months or even more than a year.
By removing inventory from the calculation, it helps management, stock investors, shareholders and other stakeholders to obtain more accurate information in assessing the liquidity position of the entity.
-
Easier to understand
One of the other advantages of the quick ratio is its ease of understanding. This ratio can help ratio users who do not have in-depth knowledge in accounting and finance to easily understand the ratio.
For example, operational managers who have a Key Performance Indicator (KPI) involving a quick ratio can see and understand how the ratio functions and highlight the challenges the ratio represents.
This ratio is measured in percentage form. So, if the ratio exceeds the set target, it indicates that certain actions need to be taken to improve it.
-
KPI size
Mudalovers can set it as a Key Performance Indicator (KPI) and compare it with different entities. This ratio compares current assets with current liabilities and is measured as a percentage.
Thus, Mudalovers can compare it with other entities or competitors that have different sizes and characteristics.
-
Disadvantages of Quick Ratio
Although the quick ratio has several advantages, it also has certain disadvantages that need to be taken into account. The following are the disadvantages of the quick ratio ratio:
-
Is a financial indicator
Quick ratios use financial information to analyze an entity’s liquidity position. This financial information can be influenced by the entity’s management if it is dishonest.
Management can influence the ratio through the accounting policies chosen or by providing inaccurate or fictitious financial information.
-
Using data from the past to predict the future
The quick ratio is used to evaluate an entity’s ability to pay current liabilities using current and future current assets. However, this may not give users an accurate picture of achieving their goals.
For example, even though an entity has a low quick ratio, the management team has a good reputation and relationships with banks or suppliers.
The company’s management team may be able to address this issue better than other entities that have high quick ratios.
That’s the discussion about the quick ratio, usually this ratio analysis is used by potential creditors and lenders to find out information about whether the company will be able to pay its debts on time or not.