ACCA Financial Management (F9) Certification Practice Exam

What does it mean if a company has a quick ratio below 1?

1. The company has strong liquidity

2. The company has faster inventory turnover

3. The company may struggle to meet short-term liabilities

4. The company is very efficient in managing current assets

The correct answer is: The company may struggle to meet short-term liabilities

A company's quick ratio is a measure of its ability to meet short-term obligations with its most liquid assets. The quick ratio is calculated as (Current Assets - Inventory) / Current Liabilities. A quick ratio of less than 1 indicates that the company does not have enough liquid assets to cover its current liabilities, meaning it could potentially face challenges in fulfilling its short-term debts. This is critical for financial health because a quick ratio below 1 suggests that, upon immediate obligation, the company may not be able to convert enough of its assets to cash to meet these obligations, which poses liquidity risk. In contrast, the other options do not accurately reflect the implications of having a quick ratio under 1. A quick ratio below 1 does not indicate strong liquidity, nor does it imply efficient inventory turnover or asset management, as the focus of the ratio is specifically on the ability to cover immediate liabilities with liquid assets, excluding inventory, which might not be readily convertible to cash.