better off<\/em> with a slightly lower Quick Ratio because it is using some of its Cash to re-invest in its business?<\/p>\nYou can see an example of the calculation for Illinois Tool Works [ITW] below (see the Excel file and filing PDF above):<\/p>\n
![\"Liquidity](\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2023\/11\/19074650\/02-Liquidity-Ratios-Quick-Ratio.jpg\" "\\"Liquidity")
<\/p>\n
The Quick Ratio here is 0.87x, which means that ITW has $0.87 of Cash + AR for each $1.00 in current liabilities.<\/p>\n
This means that ITW could\u00a0not<\/em> afford to repay all its obligations using its Cash + Owed Payments from Customers.<\/p>\nSome people would call that a negative sign, but, again,\u00a0context<\/strong> is king here.<\/p>\nIt’s only negative if the company ever enters such a stressed situation that an immediate repayment becomes necessary; if not, it means nothing.<\/p>\n
The bigger issue is that it seems like the company’s liquidity has deteriorated over the past few years<\/strong>:<\/p>\n![\"Liquidity](\"https:\/\/biwsuploads-assest.s3.amazonaws.com\/biws\/wp-content\/uploads\/2023\/11\/19074649\/04-Liquidity-Ratios-ITW.jpg\" "\\"Liquidity")
<\/p>\n
This is concerning because it suggests that ITW’s Cash balance has been falling, while its Short-Term Debt has been rising.<\/p>\n
On the other hand, even with these additional numbers, we still don’t have\u00a0the full context<\/strong>.<\/p>\nFor example, many companies raised additional Debt and Equity during the COVID-19 pandemic to boost their Cash reserves.<\/p>\n
If Illinois Tool Works did this, its FY 20 numbers may be artificially inflated – and its FY 22 numbers may simply be a “return to normal.”<\/p>\n
To determine this, we’d need to go back 10-15 years and also look at the\u00a0quarterly numbers<\/strong> rather than the simple annual ones.<\/p>\n<\/span>Quick Ratio vs. Current Ratio<\/span><\/h2>\nBoth the Quick Ratio and Current Ratio are valuable in financial analysis and are used to evaluate a company’s liquidity.<\/p>\n
However, there are distinct differences in their calculations and meaning:<\/p>\n
1) Scope of Assets Considered:<\/strong> The Quick Ratio focuses narrowly on the most-liquid assets \u2014 specifically, Cash, Cash-Equivalents, and Accounts Receivable. It is based on the idea that certain assets, such as Inventory, may not be as easily convertible into Cash, especially in a crisis or downturn.<\/p>\nOn the other hand, the Current Ratio includes all current assets, including everything above and Inventory and Prepaid Expenses.<\/p>\n
2) Conservatism:<\/strong> Given its exclusion of Inventory and other less-liquid assets, the Quick Ratio is often viewed as the more conservative<\/strong> liquidity measure. This is especially pronounced in industries with slow inventory turnover, such as spirits (alcohol) companies.<\/p>\n3) Lender Perspective:<\/strong> From a creditor’s standpoint, understanding a firm’s immediate liquidity is important. While the Current Ratio provides a broader perspective on short-term solvency, the Quick Ratio tests the company’s ability to meet its obligations without liquidating Inventory or selling other assets.<\/p>\nAs a result, lenders may weigh the Quick Ratio more heavily when assessing creditworthiness in certain contexts.<\/p>\n","protected":false},"excerpt":{"rendered":"
The Quick Ratio, commonly known as the “acid-test” ratio, is normally defined as (Cash & Cash-Equivalents + Accounts Receivable) \/ Current Liabilities, and it captures a company\u2019s ability to service its short-term obligations using its most-liquid assets.<\/p>\n","protected":false},"featured_media":0,"template":"","class_list":["post-26979","biws_kb","type-biws_kb","status-publish","hentry","kb_category-financial-statement-analysis"],"acf":[],"_links":{"self":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb\/26979","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/biws_kb"}],"about":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/types\/biws_kb"}],"wp:attachment":[{"href":"https:\/\/breakingintowallstreet.com\/wp-json\/wp\/v2\/media?parent=26979"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}