What is Quick Ratio in Mutual Funds?

Quick Ratio Meaning

The quick ratio, or acid-test ratio, is a ratio that determines the capacity of the company to cover the short-term obligations with the help of the most liquid assets. These typically include cash, assets that can be quickly converted to cash, marketable securities, and money owed by customers.

Other than returns and expense ratios, the interpretation of quick ratios can aid in the determination of the quality and soundness of the holdings and in particular during low or unpredictable market times. It does not include stock or prepaid expenses, so it gives a stricter assessment than the current ratio.

How to Calculate Quick Ratio?

The ratio is calculated using balance sheet figures as follows:

Quick Ratio = (Current Assets − Inventory − Prepaid Expenses) ÷ Current Liabilities

Alternatively:

Quick Ratio = (Cash + Marketable Securities + Accounts Receivable) ÷ Current Liabilities

Consider a company with the following balance sheet figures:

• Cash: ₹50 lakh
• Marketable Securities: ₹30 lakh
• Accounts Receivable: ₹20 lakh
• Current Liabilities: ₹80 lakh

Quick Ratio = (50 + 30 + 20) ÷ 80 = 1.25

This indicates the company holds ₹1.25 in liquid assets for every ₹1 of short-term obligations, showing that liquid assets exceed short-term obligations.

Importance of Quick Ratio for Mutual Fund Investors

The quick ratio is an important way to check the financial strength of companies in equity mutual fund portfolios.

Financial Stability Assessment

It reveals whether portfolio companies can manage short-term obligations without depending on inventory liquidation. This is especially important during low demand or supply problems when selling stock for cash becomes hard for many companies.

Risk Evaluation

A consistently low quick ratio may show cash pressure and difficulty paying short-term bills. Checking this ratio during equity analysis helps identify short-term liquidity risk.

On the other hand, a very high ratio may be a sign of poor resource utilisation, but acceptable levels depend on the industry. Manufacturing companies usually keep more inventory than service firms, so a healthy quick ratio differs by industry.

Portfolio Quality Indicator

It is the ratio that can inform investors in examining scheme documentation or annual reports and determine the risk profile held. Companies with quick ratios consistently above 1 are generally viewed as having sufficient liquid assets relative to short-term liabilities, subject to industry standards.