liquid (or) quick ratio is a measurement of a firm’s ability to convert its current assets quickly into cash in order to meet its current liabilities. It is a measure of judging the immediate ability of the firm to pay-off its current obligations.
It is calculated by dividing the quick assets by current liabilities:
Quick or Liquid Ratio = (current asset-inventory)/Current Liabilities
The term quick assets refers to current assets which can be converted into cash immediately or at a short notice without diminution of value. Thus quick assets consists of cash, marketable securities and accounts receivable. Inventories are excluded from quick assets because they are slower to convert into cash and generally exhibit more uncertainty as to the conversion price.This ratio provides a more stringent test of solvency. 1:1 ratio is considered ideal ratio for a firm because it is wise to keep the liquid assets at least equal to the current liabilities at all times.