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Inventories take time to be converted into cash, and if they have to be sold quickly, the company may have to accept a lower price than book value of these inventories as its related for several factors like competitor strong, distribute in the market & seasonality.
But account receivable is can be transferred to cash faster & with lower cost through factoring, give early payment discount or increase the collection commission.
We exclude the item Inventory because it is the least liquid among the current assets since this item when sold is presumed to be included in the Accounts Receivable account before it will be converted to Cash. Account Receivable is included since this item will surely be converted to cash.
Reason for exclusion of Inventory :-The quick ratio is done to determine the company's ability to meet its short-term obligation with its most liquid assets. Hence while calculating the quick ratio inventory is excluded from the current assets.
The quick ratio is more conservative than the current ratio because it excludes inventories from current assets. The ratio derives its name presumably from the fact that assets such as cash and marketable securities are quick sources of cash. Inventories generally take time to be converted into cash, and if they have to be sold quickly, the company may have to accept a lower price than book value of these inventories. As a result, they are justifiably excluded from assets that are ready sources of immediate cash.
Reason for Inclusion of Accounts Receivable :- Whether “accounts receivable” is a source of ready cash is debatable, however, and depends on the credit terms that the company extends to its customers. A firm that gives its customers only30 days to pay will obviously be in a better liquidity position than one that gives them90 days. But the liquidity position also depends on the credit terms the company has negotiated from its suppliers. For example, if a firm gives its customers90 days to pay, but has120 days to pay its suppliers, its liquidity position may be reasonable.
agree with Mr maged glal ...
= (Cash and equivalents + Marketable securities + Accounts receivable) / Current liabilities
The quick ratio measures a company’s ability to meet its short-term obligations with its most liquid assets, and therefore excludes inventories from its current assets. It is also known as the “acid-test ratio.”
DSO refers to the average number of days it takes a company to collect payment after it makes a sale. A higher DSO means that a company is taking unduly long to collect payment and is tying up capital in receivables. DSOs are generally calculated quarterly or annually.
In calculation of Quick ratio, inventory has to exclude from current asset. Normally inventory is not purchase for selling, it is purchase for production. Accounts Receivable is the stage for receiving money only. So it is included as quick assets.
In acid test ratio we exclude the inventory because in is not a liquid asset or if we want to sale the inventory it will not be sale at the cost which is currently showing in the balance sheet, where as the account receivables which we are using of the calculation of this ratio is net of bad debts i.e. we are100% sure that it we recoverable.
If you don't want to exclude inventory, then why are you calculating Quick Ratio. Just focus on Current Ratio.
Company's use this Quick ratios, because they want to know how much we have current assets, that are quickly converted to cash. So, inventory's are not quickly converted,
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