Quick ratio for due diligence
Pre-LOI screen, quarterly trend analysis, and working-capital adjustment input. How M&A teams put the acid-test to work.
M&A and private equity diligence teams use the quick ratio at three points in the deal cycle: as a one-glance screen before the letter of intent (LOI), as a quarterly trend during confirmatory diligence, and as a normalisation input for the working capital peg in the purchase agreement. A target with a quick ratio declining over four consecutive quarters is treated as a deal-risk item even if absolute levels remain inside the sector band.
Verified June 2026. Source: White, Sondhi and Fried, The Analysis and Use of Financial Statements, 3rd Edition (pp. 111-118).
Three checkpoints in the deal cycle
1. Pre-LOI screen
Pull the most recent annual filing or audited statement. Compute the quick ratio and compare against the sector band. A target one full point below the sector floor is a strong signal to walk before deeper diligence costs accumulate.
2. Confirmatory diligence
Pull the last 8 to 12 quarters of unaudited management accounts. Compute quarterly quick ratios. Plot the trend. Cross-reference against AR aging, inventory turnover, and supplier payment terms. Falling quick ratio with stable inventory days suggests cash burn; falling quick ratio with rising inventory days suggests stock obsolescence.
3. Working capital peg
The purchase agreement typically includes a target working capital level (the peg) with a true-up at closing. Quick ratio trends inform the peg negotiation. A target consistently operating below sector quick ratio bands implies the seller is running on tight working capital, which the buyer should normalise upward in the peg or accept as ongoing financing risk.
Common diligence red flags
- Quarter-end window dressing. Quick ratio spikes at quarter end and drops materially mid- quarter. Suggests draw on revolver to hit covenant, paid down the next day.
- AR concentration on a single customer. Quick ratio looks healthy but receivable risk is binary. Cash ratio is the better gauge.
- Reclassification of long-term debt to current. A bullet maturity moving inside the 12-month window can crush the quick ratio without any underlying change in business performance.
- Off-balance-sheet AR financing. Factoring, securitisation, or non-recourse AR sales reduce receivables on the balance sheet. The reported quick ratio falls; underlying liquidity does not.
Diligence checklist
- Compute quick ratio at each of the last 8 quarter ends.
- Compare each reading against the sector band.
- Plot the trend. Identify inflection points.
- Pull AR aging schedules. Compute aged AR / total AR.
- Pull inventory aging. Identify slow-moving and obsolete stock.
- Verify revolver utilisation at each quarter end vs mid-quarter.
- Inspect debt maturity schedule for upcoming bullet payments.
- Check for AR factoring or securitisation in the footnotes. Adjust quick ratio to add factored receivables back.
- Compute the cash conversion cycle quarter by quarter. Pair with quick ratio trend.
- Document any working-capital normalisation adjustments for the quality of earnings report.
Credit analysis
How lenders use the same ratio differently.
Step-by-step calculation
See the method applied to an illustrative balance sheet.