Quick Ratio
A variation of the current ratio is the quick ratio, also called the acid-test ratio, computed by including in the numerator only those current assets the firm could convert quickly into cash, often interpreted as within 90 days. The numerator customarily includes cash, marketable securities and other short-term investments, and receivables. However, you should study the facts in each case before deciding whether to include receivables and exclude inventories. Some businesses can convert their inventory into cash more quickly (for example, a firm that carries a large amount of readily salable commodities in inventory) relative to other businesses (for example, an equipment manufacturer such as John Deere that provides long-term financing for its customers’ purchases).
Assuming we include accounts receivable but exclude inventories, PepsiCo’s quick ratio at the end of 2012 is as follows
A variation of the current ratio is the quick ratio, also called the acid-test ratio, computed by including in the numerator only those current assets the firm could convert quickly into cash, often interpreted as within 90 days. The numerator customarily includes cash, marketable securities and other short-term investments, and receivables. However, you should study the facts in each case before deciding whether to include receivables and exclude inventories. Some businesses can convert their inventory into cash more quickly (for example, a firm that carries a large amount of readily salable commodities in inventory) relative to other businesses (for example, an equipment manufacturer such as John Deere that provides long-term financing for its customers’ purchases).
Assuming we include accounts receivable but exclude inventories, PepsiCo’s quick ratio at the end of 2012 is as follows
The quick ratio for PepsiCo was 0.62 at the end of 2011. Unless inventory turnovers have changed dramatically, the comparative trends in the quick ratio and the current ratio correlate highly. That is, you obtain similar information about improving or deteriorating short-term liquidity risk by examining either ratio. Note that the current and quick ratios for PepsiCo follow the same upward trend. However, the increase in the quick ratio is more pronounced. In 2012, current assets increased 7.3%, whereas current liabilities decreased 5.9%. On the other hand, the sum of cash, marketable securities, and accounts receivable increased 20.5% in 2012, leading to the increase in these amounts relative to current liabilities. Thus, the discrepancy between the current ratio and quick ratio for PepsiCo is due to changes in less liquid current assets. Indeed, the balance sheet indicates that PepsiCo decreased both inventory and prepaid expenses and other current assets in 2012. The quick ratio is subject to some of the same interpretive issues as the current ratio. That is, analysts interpret quick ratios in the context of the many other factors that affect the firm’s liquidity, including the firm’s ability to generate cash flows from operations. Appendix D again reveals significant variation in quick ratios across firms and industries.
Operating Cash Flow to Current Liabilities Ratio
Rather than use balance sheet-based metrics like the current or quick ratio, you can use more direct indicators of a firm’s ability to generate cash in the near term, such as ratios based on cash flow from operations. An intuitive measure is the ratio of cash flow from operations to current liabilities, which captures cash generated over a period, relative to the level of liabilities due within one year. Because the numerator of this ratio uses amounts for a period of time, the denominator typically uses an average of current liabilities for the same period.
This ratio for PepsiCo for 2012 is as follows
Operating Cash Flow to Current Liabilities Ratio
Rather than use balance sheet-based metrics like the current or quick ratio, you can use more direct indicators of a firm’s ability to generate cash in the near term, such as ratios based on cash flow from operations. An intuitive measure is the ratio of cash flow from operations to current liabilities, which captures cash generated over a period, relative to the level of liabilities due within one year. Because the numerator of this ratio uses amounts for a period of time, the denominator typically uses an average of current liabilities for the same period.
This ratio for PepsiCo for 2012 is as follows
The ratio was 0.41 for 2011. A ratio of 0.40 or more is common for a typical healthy manufacturing or retailing firm.5 PepsiCo exhibits an operating cash flow to current liabilities ratio well above 0.40 and the trend in 2012 is positive. Thus, PepsiCo does not display much short-term liquidity risk in terms of operating cash flows relative to current liabilities.
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