Quick assets are assets that can be quickly converted to cash without a substantial loss of value. This usually means that they can be converted in one year or less. The amount of funds that a company has in its quick assets is a measure of liquidity and solvency. Maintaining an adequate level of quick assets and a healthy quick ratio are objectives of all business managers.
What Are Quick Assets?
Quick assets are found on a company's balance sheet and are the sum of the following:
- Marketable Securities
- Accounts Receivable
- Prepaid Expenses and Taxes
Another way to find the total of quick assets is to simply subtract inventory from current assets:
Quick assets = Current Assets - Inventory
Cash includes bank accounts and any interest-bearing accounts.
The accounts receivable of a business need a detailed analysis to determine if all of the receivables are collectible. Uncollectible and stale receivables should be excluded from the total of quick assets.
Marketable securities are financial instruments that are traded on open markets with quoted prices and a ready market of buyers.
Prepaid expenses are typically consumed in the current accounting period. The most common prepaid expense is insurance.
Quick assets do not include inventory because it takes longer to sell the products and convert to cash. Some industries, such as the construction sector, may have long-term receivables that should be excluded from quick ratio to present a more accurate appraisal of the company's liquidity.
What Is the Quick Ratio?
While the amount of funds that a company has invested in quick assets is important, the ratio of quick assets to current liabilities is a more revealing metric about the liquidity of the company. The quick ratio is a stricter test for a company's liquidity compared to the current ratio. For this reason, the quick ratio is also known as the acid-test ratio.
The quick ratio is calculated as follows:
Quick Ratio = (Cash + Marketable Securities + Accounts Receivable + Prepaid Expenses)/Current Liabilities
The balance sheet of Flying Pigs Corporation has the following accounts:
- Cash: $8,000
- Accounts Receivable: $4,000
- Inventory: $9,000
- Marketable Securities: $2,000
- Prepaid Expenses: $500
- Current Liabilities: $13,000
Quick Assets = $8,000 + $4,000 + $2,000 + $500 = $14,500
Quick Ratio = $14,5000/$13,000 = 1.08
Significance of the Quick Ratio
The quick ratio is a measure of the solvency of a company. It should be monitored over a period of time for positive or negative trends and within the context of other firms in the same industry.
A quick ratio of 1:1 or higher means that the company has enough liquid assets available to pay all of its current liabilities. A ratio less than 1:1 is an indication that the company could have difficulty in paying its short-term debts on a timely basis.
In general, business managers try to maintain a quick ratio appropriate to the degree of predictability and volatility in their specific business sector. Business environments with higher levels of uncertainty require a higher quick ratio. Conversely, industries with more predictable and stable cash flows can operate comfortably with lower quick ratios. The goal is to strike a balance between having enough liquidity to handle uncertainty and having too much cash and not employing excess funds in assets with higher returns.
The amount of funds that a company has invested in quick assets depends on the type of industry. Companies that sell products and services to other corporate clients will usually have substantial funds in accounts receivable. Retail businesses, on the other hand, do not carry receivables and will have most of their quick assets in cash and marketable securities.
The total quick assets that a company maintains and the acid-test ratio are critical indicators of a firm's liquidity and its ability to remain solvent. Ultimately, companies need a stable and continuous cash flow cycle to purchase and sell products and pay their debts. Business managers constantly monitor the quality of the firm's quick assets to make sure that they can meet the company's obligations and provide a return to the shareholders.