The Quick Ratio tells us whether a farmer or rancher will enough money from the most liquid assets to cover their debts in the next year.
The most liquid assets are things like cash, marketable securities and accounts receivable.
The current ratio is one of the important liquidity ratios which helps farmers and financial analysts determine whether a farm or ranch can meet short-term loan obligations.
Quick Ratio Formula
Quick Ratio = (Cash & Equivalents + Marketable Securities + Accounts Receivables) ÷ Current Liabilities
This article is a part of our series on Farm Financial Performance Ratios.
Description
In agricultural accounting, the quick ratio provides a the most conservative measure of liquidity by assuming only the most liquid current assets, such as cash, marketable securities and accounts receivables, are used as a part of the assessment.
It assesses the company’s ability to meet short-term liabilities using its most liquid assets. It is calculated by dividing liquid assets (cash, marketable securities and accounts receivables) by current liabilities.
Please Note: The quick ratio is very closely related to the current ratio, however, the drawback with the current ratio is that not all current assets can always be assumed to convert easily to cash every year. For this reason, the ratio assumes only cash or liquid assets are assumed.
Calculating the Quick Ratio
The quick ratio is calculated by taking the sum of liquid asset (cash, marketable securities and accounts receivables) and dividing by the total current liabilities.
Quick Ratio = (Cash & Cash Equivalents + Marketable Securities + Accounts Receivables) ÷ Current Liabilities
- Cash and Cash Equivalents includes assets such as cash on hand and amounts in checking and savings accounts.
- Marketable Securities includes stocks and bonds.
- Accounts receivables are the amounts owed to a farmer or rancher by its customers for goods sold or services rendered on credit.
- Current liabilities are obligations due within the same time frame, such as accounts payable, short-term loans, and other debts maturing within a year.
The cash, marketable securities, accounts receivables and total current liabilities can all be found on an agricultural balance sheet.
Guided Example
Say for example, John, a farmer, has total cash of $25,000, marketable securities of $15,000 and accounts receivables of $10,000 on his balance sheet. Also assume that he has $20,000 in loan payments and wages he owes to his employees in the coming twelve months.
To calculate a quick ratio, start by taking our formula:
Quick Ratio = (Cash & Cash Equivalents + Marketable Securities + Accounts Receivables) ÷ Current Liabilities
Then plug in the cash, marketable securities, accounts receivables and current liabilities into the formula:
Quick Ratio = ($25,000 + $15,000 + $10,000) ÷ $20,000
Using these variables, we arrive at 2.5x as the quick ratio result.
2.5 = $50,000 ÷ $20,000
What this tells us is that John has enough highly liquid assets which can be conservatively converted to cash in the next year to cover his known liabilities due in the next year 2.5x over. This is good!
Ideal Quick Ratio for Farmers & Ranchers
For agricultural businesses, where cash flow can be variable highly variable. This is due to factors like seasonal fluctuations in crop yields, weather conditions, and market volatility. As such, maintaining a healthy quick ratio is crucial for ensuring financial stability and the ability to manage operational expenses and debt obligations effectively.
Ideally, the quick ratio should be at least 1, meaning that there are ample highly-liquid assets to cover liabilities in the short term. If there are not enough liquid assets to cover liabilities in the short term, then the farmer or rancher runs the risk of being in default of their debt obligations.
To create a margin for safety, farmers should strive to have a quick ratio of at least 1.3x to 2.0x. Anything higher than 2.0x means the farmer or rancher is excellent condition to meet their short term obligations.
How to Improve Your Quick Ratio
To improve your quick ratio, your strategy should be aimed at either increasing your current assets and/or decreasing your current liabilities.
Here are some strategies you can consider:
To Increase current assets:
- Increase cash reserves. Focus on building up cash reserves by retaining profits, reducing unnecessary expenditures, and implementing cash flow management techniques.
- Improve Marketable Securities Position. Build an additional reserve of marketable bonds and securities. This has the added benefit of diversifying your revenue stream.
- Accelerate accounts receivable collections. Implement strategies to shorten the collection period for accounts receivable. Offer discounts for early payments or incentivize prompt payments to reduce the average collection period.
To Decrease current liabilities:
- Negotiate better payment terms. Negotiate longer payment terms with suppliers to delay outgoing payments, thus extending the timeframe for settling accounts payable.
- Refinance short-term debt. Consider refinancing short-term loans with longer-term options to reduce the portion of debt due within the next year, thus lowering current liabilities.
- Manage operating expenses. Review and optimize your operating expenses to identify areas where costs can be reduced without compromising productivity or quality.
How the Quick Ratio is Used
The quick ratio is a crucial financial metric used by agricultural businesses, as well as businesses across various industries, to assess their short-term liquidity and financial health.
Farmers and Ranchers us the quick ratio to understand the overall health of their operation. If the quick ratio continues to grow, that is a sign of a healthy operation that is able to meet short term needs using the most liquid of assets!
Lender use the quick ratio to assess the ability of a farm or ranch to meet their short term obligations with liquid assets. If a farmer is unable to pay their debts due in the next year, there is risk of default. Conversely, farmers and ranchers borrowing from a bank may get preferred or better rates when the lender knows there is greater certainty of repayment.