Quick ratio

A ratio compares two figures to reveal something neither number shows on its own. The quick ratio compares what a company can turn into cash almost immediately against what it owes within a year, a stricter test of short-term solvency than the current ratio.

The quick ratio divides current assets, excluding inventory, by current liabilities. Inventory is left out because it can take time to sell and is not guaranteed to convert to cash at its stated value, especially if a company is under pressure and forced to discount it.

The formula is: (Current assets - Inventory) / Current liabilities.

A quick ratio above 1 means a company could cover its near-term obligations without relying on selling inventory, a stronger sign of liquidity than the current ratio alone provides. A ratio below 1 suggests the company would need to sell inventory, raise new financing, or generate cash from operations to meet its short-term obligations if they all came due at once.

The gap between a company's current ratio and its quick ratio shows how reliant it is on inventory for short-term liquidity. A large gap is normal and expected for a retailer or manufacturer carrying substantial inventory, but far more concerning for a software or services business, where inventory should be minimal to begin with.