Key Points
- The quick ratio excludes inventory because inventory may not convert to cash quickly enough to cover obligations falling due.
- A ratio below 1.0 signals that current liabilities exceed liquid assets, which is one of the standard going concern warning indicators.
- Most analysts treat a quick ratio between 1.0 and 1.5 as adequate for manufacturing and distribution entities, though the acceptable range varies by industry.
- Auditors calculate the quick ratio alongside the current ratio in preliminary analytical procedures to identify liquidity risk early in the engagement.
What is the Quick Ratio / Acid-Test Ratio?
The formula is straightforward: take cash and cash equivalents, add short-term receivables and marketable securities, then divide by current liabilities. Some practitioners call this the acid-test ratio because it strips away inventory and other current assets that cannot be liquidated on short notice.
ISA 520.5 requires the auditor to design and perform analytical procedures as risk assessment procedures near the start of the engagement. The quick ratio sits at the centre of that liquidity analysis. When the ratio drops below 1.0, the audit team needs to evaluate whether the entity can meet its obligations as they fall due over the next twelve months. ISA 570.10 lists "net current liability position" as one of the financial indicators that may cast significant doubt on going concern. A declining quick ratio over consecutive periods, even if it remains above 1.0, can indicate a trajectory that warrants further investigation under ISA 570.16.
The ratio is most useful when compared across periods and against industry benchmarks. A quick ratio of 0.8 at a grocery retailer with daily cash inflows carries a different risk profile than 0.8 at a construction firm waiting 90 days on receivables. The auditor documents the context, not just the number.
Worked example: Henriksen Shipping A/S
Client: Danish maritime logistics company, FY2025, revenue EUR 140M, IFRS reporter. The audit team is performing preliminary analytical procedures at planning stage.
Step 1 — Extract the components from the draft balance sheet
Cash and cash equivalents EUR 8.2M. Trade receivables (net of allowance) EUR 22.6M. Marketable securities (short-term bond fund) EUR 3.1M. Current liabilities EUR 41.5M. Inventory (bunker fuel, spare parts) EUR 6.8M.
Step 2 — Calculate the quick ratio
(EUR 8.2M + EUR 22.6M + EUR 3.1M) / EUR 41.5M = EUR 33.9M / EUR 41.5M = 0.817.
Step 3 — Compare against prior periods and benchmarks
FY2024 quick ratio was 1.04. FY2023 was 1.12. The ratio has declined in each of the last two years. The European maritime logistics sector median is approximately 0.95. Henriksen sits below both its own trend and the sector median.
Step 4 — Evaluate the implications for the audit
The ratio below 1.0 means liquid assets do not cover current liabilities. The engagement team reviews the maturity profile: EUR 18M of the EUR 41.5M is a revolving credit facility maturing in June 2026, and management holds a signed bank commitment letter for renewal. The twelve-month cash flow forecast projects positive operating cash flow of EUR 14M.
Conclusion: Henriksen's quick ratio of 0.817 is a genuine risk indicator that the audit team investigated rather than dismissed, and the documented evaluation of the facility renewal and cash flow forecast gives the reviewer a defensible audit trail.
Why it matters in practice
- Teams calculate the quick ratio at year-end but do not compare it to interim periods or the prior year. ISA 520.5(a) requires the auditor to develop an expectation based on prior periods, industry data, or both. When the working paper contains only the year-end calculation with no trend analysis, reviewers flag the analytical procedure as insufficient.
- Receivables included in the numerator sometimes contain balances that are not genuinely liquid (related party receivables with no fixed settlement date, or long-overdue balances not yet written off). If those receivables will not convert to cash within the relevant timeframe, the ratio overstates liquidity and the going concern assessment under ISA 570.10 rests on a flawed input.
Quick ratio vs. current ratio
| Dimension | Quick ratio | Current ratio |
|---|---|---|
| Numerator | Cash + short-term receivables + marketable securities only | All current assets, including inventory and prepaid expenses |
| What it tests | Whether the entity can meet current obligations without selling inventory | Whether total current assets cover current liabilities |
| Sensitivity to inventory | High: excludes inventory entirely, so the ratio drops sharply when liquid assets are thin | Low: a large inventory balance can produce a healthy-looking ratio even when cash is scarce |
| When it matters most | Entities where inventory is slow-moving or hard to liquidate (construction, manufacturing with long production cycles) | Entities with fast-turning inventory that reliably converts to cash (grocery retail, fuel distribution) |
| Audit use | Stronger indicator for ISA 570 liquidity assessment because it isolates genuinely liquid resources | Useful as a first-pass measure but must be supplemented by the quick ratio to identify inventory dependence |
The quick ratio is the sharper test. An entity with a current ratio of 1.8 and a quick ratio of 0.6 is sitting on inventory it cannot quickly convert. That gap between the two ratios is itself worth documenting, because it tells the engagement partner where the liquidity risk sits.
Related terms
Frequently asked questions
What is the difference between the quick ratio and the current ratio?
The current ratio includes all current assets in the numerator, including inventory and prepaid expenses that may take months to convert to cash. The quick ratio excludes these less liquid items and retains only cash, receivables, marketable securities, and similar liquid instruments. ISA 520.5 does not prescribe which ratio to use, but calculating both gives the auditor a clearer view of whether inventory is masking a liquidity gap.
Does a quick ratio below 1.0 automatically mean there is a going concern problem?
No. ISA 570.10 lists a net current liability position as one indicator, not a determinative threshold. An entity with a quick ratio of 0.7 but strong recurring cash inflows (a subscription-based SaaS company, for example) may face no realistic going concern risk. The auditor evaluates the ratio alongside cash flow forecasts and the maturity profile of liabilities under ISA 570.16, factoring in available credit facilities where relevant.
How do I document the quick ratio in the audit working papers?
Record the formula, each input with its trial balance reference, the calculated result, prior-period comparatives, and the industry benchmark source. State whether the ratio indicates a potential liquidity risk requiring further procedures under ISA 570, or whether it is consistent with expectations formed at planning. ISA 520.6 requires the auditor to investigate unexpected results, so document why a decline was or was not expected.