Quick ratio can best the best determinant of liquidity measures within a company. As a matter of fact, it can be seen as a measure to validate the organization’s ability to meet its day to day expenses and other short-term liabilities like accounts payable and accrued interest expenses.
In this article, we will discuss the ways how a company could use to improve the quick ratio when the calculation shows that ratio performance is not meet the expectation of company management.
The quick ratio or acid-test ratio can be calculated through the following formula:
(Current assets – inventory) / Current Liabilities
How to improve quick ratio?
Often the greatest organizations are faced with the greatest challenges pertaining to liquidity, to an extent where they are often forced to shut down.
Therefore, given the overall importance of ensuring liquidity within the firm, it is really rudimentary for organizations, regardless of their size to ensure that they follow certain protocols to improve their quick ratio.
- Increasing Sales and Inventory Turnover: There is no doubt to the fact that Sales and Inventory Turnover are some of the greatest determinants to gauge business standing. However, in order to improve the liquid resources your business has in hand, it gets pivotal to increase the sales for your company. In return, this will increase inventory turnover. Having greater turnover means greater cash in hand for the company, and hence, greater sales.
- Improving Invoice Collection Period: Long-term Debts extended to clients are often one of the biggest reason for a company’s inability to meet its expenses. As a result, it often gets challenging to manage cash, and despite the fact that one might have greater sales and assets (long-term debtors), the liquidity position might get gruesome. It also increases the company’s exposure towards risk, because of the chance of clients defaulting on those debt gets higher, and significantly increases the probability of increased bad debts for the company. Therefore, by giving long-debtors discounts in order to attract them to pay early, your organization can quickly convert long term assets into cash, thereby increasing the liquidity you have at your disposal.
- Paying off liabilities quickly: Current liabilities tend to have an inverse relationship with quick ratio, which should, therefore, be decreased. This can be achieved by ensuring that you are able to pay back liabilities in due time.
- Discarding unproductive assets: Often in an organization, the corporation has certain assets lined up which do not generate any considerable revenue for the company. These assets need to be identified and then discarded in order to get cash against those assets. This cash can then be taken for short term liquidity of the company, hence improving the quick ratio of the company.
- Drawings: As far as drawings are concerned, it can be seen that drawings from business owners should also be prioritized and kept at a minimum. If your business is a partnership, then there should be strict preventions to ensure that there are no withdrawals in the form of drawings, because that just takes a heavy toll on the existing cash in the company.
In addition to the features listed above, it can further be stated that the best manner to ensure that your company has an improved quick ratio is to ensure that there are strategies and plans decided which can ensure that there are sufficient funds and paybacks to facilitate the working capital of the business.
By investing less in inventory (adopting policies like Just in Time), you can ensure that you do not have a lot of money tied up in inventory.
Similarly, by ensuring that you are able to keep your credit limits in check for long term debtors, your business can have sufficient cash on hand to be able to manage the day to day expenses in a viable manner.
It is absolutely crucial that one does a holistic analysis of the Current Assets and Liabilities for the company so that it is easy to analyze which aspect needs to be highlighted and taken care of.