Current and quick ratio is a financial measure that assess a company’s capacity to pay short-term loans. The fundamental distinction between the two ratios is the period under consideration and the definition of current assets.
The current ratio measures a company’s capacity to offset current liabilities or short-term debts with existing assets. It’s also referred to as the working capital ratio.
Account receivables, cash and cash equivalents, securities, inventories, and prepaid costs are the most prevalent current assets. Accrued liabilities, accounts payable, short-term debts, and other debts are examples of current liabilities.
Current Ratio Formula
A simple formula is used to calculate current ratio:
Current Ratio = Current Assets /Current Liabilities
To calculate the current ratio, add up all of your company’s existing assets and divide them by the entire amount of current liabilities.
For example, suppose your company’s total current assets are $500,000, and its total current liabilities are $200,000. Your current ratio is $500k/$200k = 2.5.
That means your company has $3 in total assets for every $1 in current liabilities.
An excellent Current Ratio would be two since it allows you to pay off your creditors without causing liquidity problems simply. Anything less than two places your company in the danger zone. It means you have a liquidity problem and don’t have adequate assets to pay off your present debts.
A high current ratio may appear to be beneficial, but anything greater than four is troublesome. It suggests that the company’s assets are underutilized.
Quick ratio, also known as the acid test ratio, is a conservative indicator of your company’s liquidity since it employs a portion of your current assets. Quick ratio calculations, unlike current ratio calculations, only employ quick assets or short-term investments that can be converted to cash in 90 days or less.
In your quick ratio computations, you’ll include cash and cash equivalents, accounts receivable, and marketable securities. When calculating quick ratios, you often exclude inventories and prepaid costs since they cannot be converted into cash in 90 days.
Current liabilities, on the other hand, stay the same and include: short-term debt, accrued liabilities, and accounts payable.
Quick Ratio Formula
While the fast ratio method employs current liabilities, it scales down the assets to meet the short duration, which is generally three months.
Quick Ratio = (Cash + Cash Equivalents + Liquid Securities + Receivables) / Current Liabilities
From the example above, a quick recalculation shows your firm now holds $200,000 in current assets while the current liabilities remain at $150,000.
The firm’s quick ratio is : 200,000 / 150,000 = 1.3
After removing inventory and prepaid expenses, your business has $1.3 in assets for every dollar in liabilities, which is a great ratio.
A quick ratio greater than one is ideal since it indicates an equal match between your assets and debts. Anything less than one indicates that your company may suffer to satisfy its financial responsibilities.
If the quick ratio is too high, the company is not making the most use of its resources. While this formula provides insights into practically every business sector, it does not effectively define the SaaS model.
Critical distinctions between current & quick ratios
Because they represent a company’s short-term liquidity, the quick and current ratios are termed liquidity ratios. Because the ratios are calculated using the firm’s account receivables, they are a good predictor of its financial health and capacity to satisfy its current liabilities.
However, there are several significant distinctions between the current ratio and the quick ratio:
- Current ratio calculations take into account all of the company’s existing assets, whereas quick ratio calculations solely take quick or liquid assets into account.
- A company’s quick ratio is considered conservative since it provides short-term insights (approximately three months), whereas the current ratio includes long-term information (a year or longer).
- The quick ratio solely considers assets that can be liquidated and turned into cash in 90 days or less. The current ratio considers all holdings that can be liquidated and turned into cash in less than a year.
- A company’s quick ratio does not include inventory in its computations, but its current ratio does.
- A 2:1 outcome is appropriate for the current ratio; however, a 1:1 quick ratio result is ideal for most businesses except SaaS.
SaaS Quick Ratio = (New MRR + Expansion MRR + Reactivation MRR) / Contraction MRR + Churn MRR)
Let’s assume these are the figures from your SaaS financial accounts:
New MRR: $400,000
Reactivation MRR: $200,000
Expansion MRR: $175,000
Churned MRR: $80,000
Your SaaS Quick Ratio = ($400+ $200k +175k) ÷ $80k = 9.68
According to the financial analysis, your company is steadily growing. The company’s outstanding growth MRR and minimal churn are obvious, but calculating the SaaS quick ratio puts everything into perspective.
A SaaS quick ratio provides deep insights into your company’s performance while indicating which areas require improvement. If your SaaS quick ratio is as follows:
< 1: You might not make it through the next two months or less.
1 to 4: You’ll run into cash flow issues if the growth MRR does not improve.
4: Your company’s growth is efficient, and you have an outstanding growth trajectory. For every dollar you lose or churn, you recoup four or more times your investment in growth MRR.
According to the previous example, this company’s financial health is in the green. It recovers over $9.68 for every $1 lost or churned.
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