Financial modelling terms explained

# Acid Test Ratio

Acid test ratio is a financial ratio that measures the relationship between net operating assets and current liabilities on a balance sheet. It is also referred to as quick ratio.

## What is the Acid Test Ratio?

The acid test ratio, also known as the quick ratio, is a liquidity ratio that measures a company's ability to pay short-term obligations using only its most liquid assets. The acid test ratio is calculated by dividing a company's current assets (cash, accounts receivable, and inventory) by its current liabilities (short-term debt and accounts payable). The higher the acid test ratio, the more liquid the company's assets are.

The acid test ratio is particularly important for companies that rely on inventory to generate sales. Inventories can be difficult to sell in a hurry, so a high acid test ratio indicates that a company is likely to have enough cash on hand to pay its short-term obligations. A low acid test ratio, on the other hand, could indicate that a company is in danger of running out of cash and may not be able to pay its bills.

## How Do You Calculate the Acid Test Ratio?

The acid test ratio, or quick ratio, is a liquidity ratio that measures a company's ability to meet short-term obligations with its most liquid assets. The acid test ratio is calculated by dividing a company's current assets by its current liabilities.

The acid test ratio is also known as the quick ratio because it is a more accurate measure of a company's liquidity than the current ratio. The current ratio includes inventory and other less-liquid assets in its calculation, while the acid test ratio does not.

The acid test ratio is a good measure of a company's short-term liquidity because it measures a company's ability to meet its short-term obligations using only its most liquid assets. A company with a high acid test ratio is more likely to be able to meet its short-term obligations.

## What Is the Difference Between the Acid Test Ratio and the Quick Ratio?

The acid test ratio, also known as the quick ratio, is a liquidity ratio that measures a company's ability to pay its short-term liabilities with its short-term assets. The quick ratio is calculated by dividing a company's current assets by its current liabilities.

The acid test ratio is more stringent than the quick ratio because it excludes inventory from current assets. The inventory may be sold in the near future to pay the company's short-term liabilities.

The acid test ratio is also known as the quick ratio, the liquidity ratio, and the working capital ratio.

## Why Is the Acid Test Ratio Also Called the Cash Ratio?

The acid test ratio, or cash ratio, is a liquidity ratio that measures a company's ability to meet its short-term obligations with its most liquid assets. The acid test ratio is also called the cash ratio because it only considers a company's most liquid assets, which are its cash and cash equivalents.

A company's most liquid assets are its most easily converted into cash. This is important because a company's short-term obligations, such as accounts payable and notes payable, need to be paid within a short period of time. A company's most liquid assets can be quickly converted into cash to pay these obligations.

The acid test ratio is a more stringent measure of liquidity than the current ratio. The current ratio measures a company's ability to meet its short-term obligations with its current assets, which includes both its liquid and non-liquid assets.

The acid test ratio is important for investors because it indicates a company's ability to meet its short-term obligations. If a company has a low acid test ratio, it may not be able to meet its short-term obligations, which could lead to a financial crisis.

## What is the Difference Between the Acid Test Ratio and the Current Ratio?

The acid test ratio, or quick ratio, is a measure of a company's liquidity. It is calculated by dividing a company's current assets by its current liabilities. The current ratio is a measure of a company's liquidity and its ability to pay its short-term obligations. It is calculated by dividing a company's current assets by its current liabilities.

## What is an Example of the Acid Test Ratio?

The acid test ratio, also known as the quick ratio, measures a company's ability to meet its short-term liabilities with its most liquid assets. This ratio is calculated by dividing a company's current assets minus its inventory by its current liabilities. An acid test ratio of 1.0 or greater indicates that a company has enough liquid assets to cover its short-term liabilities.

An example of the acid test ratio can be seen in the table below. In this example, the acid test ratio is 1.5, indicating that the company has enough liquid assets to cover its short-term liabilities.

Company A

Current Assets: \$10,000

Inventory: \$1,000

Current Liabilities: \$5,000

Acid Test Ratio: 1.5

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