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Disclaimer: This communication is provided for information purposes only and is not intended as a recommendation or a solicitation to buy, sell or hold any investment product. Readers are solely responsible for their own investment decisions.
In our journey to building a robust stock portfolio, financial health takes center stage.
Today, we delve into the Quick Ratio (also known as Acid-test ratio), a key indicator of a company's ability to meet its short-term obligations.
Quick Ratio formula
Quick Ratio = (Cash & Cash Equivalents + Accounts Receivable) / Current Liability
Why should investors aim for companies with a Quick Ratio > 1?
Think of the Quick Ratio as a company's "rainy day" fund. It measures how easily and quickly they can settle short-term debts (within a year) using their most liquid assets. These assets are like cash, marketable securities, and accounts receivable - readily convertible to cash without significant loss in value.
A Quick Ratio exceeding 1 signifies that a company has more than enough readily available resources to cover its immediate financial commitments.
This translates to:
Reduced risk of default: Investors are reassured that the company is unlikely to face difficulty meeting its short-term obligations, minimizing the chance of defaulting on loans or payments.
Enhanced financial flexibility: A strong Quick Ratio allows companies to navigate unexpected financial situations, like economic downturns, without resorting to drastic measures like selling essential assets or taking on additional debt.
Potential for growth: Companies with a healthy Quick Ratio can invest in expansion opportunities and strategic initiatives with greater confidence, paving the way for potential future growth.
How to find Quick Ratio ratios of companies?
Instead of having to manually calculate the Quick Ratios for the companies you are interested in analysing,
you can find them for free on sites like StockAnalysis.com.
Search for your companies, look for "Quick Ratio" under Financials > Ratios.
Example of companies where Quick ratio > 1
Fortinet's Quick Ratio has been above 1 since 2014, although it is in a falling trend.
Tesla's Quick Ratio is showing to be mostly above 1 since 2020.
Example of companies where Quick ratio < 1
General Motor's Quick ratio has consistently been less than 1 since 2014
Same goes to Toyota, although they are nearing 1 in the latest reported figure.
Conclusion
By understanding the Quick Ratio, you can equip yourself to make informed investment choices and build a portfolio positioned for long-term success.
While a Quick Ratio > 1 is generally desirable, the ideal ratio can vary depending on the industry and business model. It's crucial to compare companies within the same sector for a more accurate assessment.
The Quick Ratio is just one piece of the puzzle. Always consider a company's overall financial health through various other ratios and financial statements before making investment decisions.
Stay tuned for the next chapter in our series, where we'll explore other crucial financial health metrics!
