Question

Which of the following is NOT TRUE of the quick ratio?

A firm's quick ratio can better be understood when compared to an industry competitor or a best in class

Inventory is subtracted from current assets because it may not be as liquid as other assets

Higher quick ratios are preferred to lower quick ratios

It is best used in conjunction with other ratios when assessing a supplier's financial health

It is the ratio of a supplier's on-time delivery compared to all deliveries

Answer 1

Quick ratio = (current assets - Inventory) / Current liabilities

Higher quick ratio means, the numerator in the above formula is greater than that of the denominator. That means, Current liabilities are lower than the current assets excluding inventory. Hence firm will be better able to liquidate its current assets and generate cash to attend the short-term obligation in case of necessity. Hence, higher quick ratios are preferred to lower quick ratio. So option 3 is true.

Quick ratio is the firm's ability to meet the short-term obligations using its most liquid assets like cash, marketable securities, accounts receivable etc. Inventory is subtracted as it is not easily convertible to cash to repay the short-term immediate debt obligation. So inventory is subtracted from current assets as it may not be as liquid as other assets. (option 2 is true)

Financial health of a firm is assessed by using various ratios like profitability ratios, liquidity ratios, leverage ratios, efficiency ratios. Quick ratio is one among the liquidity ratio. So it is used in conjunction with other ratios to assess the financial strength of the company. So option 4 is also true.

In general, to compare financial health of a firm to that of the competitor, industry average is taken to understand the stand of the subject company. Liquidity factors of the competitor and industry average is considered to analyse the subject company's liquidity status. Hence option 1 is true.

On-time delivery ratio is used to assess the supplier's delivery ratio. It is equal to number of units at one specific time divided by the total units shipped. Quick ratio is related to the liquidity ratio and not to the delivery ratios. Hence ratio of a supplier's on-time delivery is not true about quick ratio.

Answer: option 5 (It is the ratio of a supplier's on time-delivery compared to all deliveries)