Acid-Test Ratio

The acid-test ratio, also known as the quick ratio, is a financial metric that measures a company’s ability to pay off its short-term liabilities using its most liquid assets, excluding inventory. This ratio is a stricter test of liquidity than the current ratio because it only considers assets that can quickly be converted into cash, such as cash itself, accounts receivable, and short-term investments.

Example

If a company has $150,000 in cash and accounts receivable, and $100,000 in current liabilities, its acid-test ratio would be 1.5, indicating strong liquidity.

Key points

• Measures a company’s ability to meet short-term liabilities with its most liquid assets.

• Excludes inventory from the calculation, providing a stricter measure of liquidity.

• A ratio of 1 or above is generally considered healthy.

Quick Answers to Curious Questions

What does the acid-test ratio indicate?

It indicates a company’s ability to pay off its short-term liabilities using only its most liquid assets, without relying on inventory.

How is the acid-test ratio different from the current ratio?

The acid-test ratio excludes inventory from assets, while the current ratio includes it, making the acid-test a more conservative measure of liquidity.