What Is the Quick Liquidity Ratio?
Let me explain the quick liquidity ratio directly: it's the total of a company's quick assets divided by the sum of its net liabilities, and for insurance companies, that includes reinsurance liabilities. In simple terms, it tells you how much easily convertible-to-cash assets—like cash, short-term investments, equities, and bonds nearing maturity—an insurance company has on hand to meet its financial obligations quickly.
You might also hear it called the acid-test ratio or just the quick ratio.
Key Takeaways
Here's what you need to know: the quick liquidity ratio divides a company's quick assets by its net liabilities, including reinsurance for insurers. This is one of the toughest ways to check if a debtor can pay off current debts without bringing in outside money. For insurance companies, it's a key indicator of their ability to cover liabilities with liquid assets. If an insurer's ratio is high, it's better positioned to handle payments than one with a lower ratio.
How the Quick Liquidity Ratio Works
As an investor, you have various liquidity ratios to evaluate how quickly and cheaply a company can turn assets into cash. The quick liquidity ratio focuses on assets that can become cash without losing value in 90 days or less, making it one of the strictest tests of a debtor's ability to pay short-term debts without external funding.
We express these ratios as percentages—the higher the percentage, the more liquid the company and the better it can pay what it owes.
Keep this in mind: if a company has a low quick liquidity ratio and liabilities suddenly spike, it might need to sell long-term assets or borrow money.
Example of the Quick Liquidity Ratio
Consider this for insurance companies: the quick liquidity ratio shows how well they can cover liabilities with liquid assets. Imagine an insurer with heavy property coverage in Florida hit by a hurricane. It will need more money than usual for claims. If its quick liquidity ratio is high, it's in a stronger position to pay out compared to one with a lower ratio.
Quick Liquidity Ratio vs. Current Ratio
Both the quick liquidity ratio and the current ratio measure short-term liquidity, meaning a company's ability to generate cash to pay all debts if they come due immediately. But the quick ratio is more conservative because it considers fewer assets.
It refines the current ratio by looking only at the most liquid current assets to cover liabilities, excluding inventory and prepaid expenses that are harder and slower to convert to cash.
This can lead to big differences between the two ratios. For example, a company with lots of inventory might show a high current ratio but a low quick ratio. If you're worried about short-term liabilities, you might ignore the current ratio and focus on the quick one, knowing inventory could be tough to sell quickly enough for sudden obligations.
Special Considerations
When you're looking at an insurance company with a mix of policy types, compare it to similar peers, not to those with a narrower range of products.
As an investor, evaluate the types of plans offered and how the company plans to cover liabilities in emergencies. What's considered a 'good' ratio varies by policy type—property insurers often have ratios over 30 percent, while liability insurers might be above 20 percent.
Don't stop at the quick liquidity ratio; check the current liquidity ratio for coverage with invested assets, and the overall liquidity ratio for total assets. Also, review operating cash flows and net cash flows to see how the company meets short-term needs from cash.
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