Monday, August 27, 2007

How To Use The Quick Ratio

How well would your company perform if it lost all of it's inventory? How long could it last? How would it stack up against an industry competitor? These are a few of the questions that may be answered with the use of the Quick Ratio.

Named the "Quick" ratio because it is fairly quick to calculate, this ratio is a quick way for financial analysts to compare the fundamentals of a stock. Crack open the annual report and pull out the Balance Sheet for two related companies, because you'll need them to compare ratios.

The Ratio is calculated as the Current Assets minus the inventory, and then divided by the Current Liabilities. Let's take a quick look at Coke vs Pepsi as an example to see which stock is the real thing. Values are left in the millions just to make calculating easier.

For Year 2006:Coca-ColaPepsi
Current Assets$8441$9130
Less inventory$1641$1926
Divide Cur. Liabilities$8890$6860
QUICK RATIO0.7651.050

As you can see, according to the ratio, Pepsi may be in a better position to absorb a hit on inventories (and thus revenue sales) than Coke. This is just one example. When using the Quick Ratio, it is best to compare companies within their own industry. Coke vs Pepsi makes some sense since they produce very similar products. Comparing quick ratios between Coke vs Evergreen Solar is meaningless because the companies do completely different things.

If anyone would like to submit additional advice for using the quick ratio, please submit a comment for this blog. Thanks for visiting.

-------Sincerely, Trevor Stasik.

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