The acid test ratio, which is also known as the quick ratio, is a type a liquidity ratio that measures a company’s ability to pay its short-term debts. It compares a company’s most-liquid assets, or those that can be quickly converted into cash, to its short-term debts. The ratio equals the sum of a company’s cash, short-term investments and accounts receivable divided by its current liabilities. The ratio excludes inventory from current assets, which is not as liquid as the other assets. A ratio greater than one means a company can pay its short-term debts. A ratio less than one means a company may have trouble paying its short-term bills.
Find cash, short-term investments and accounts receivable on a company’s balance sheet listed in the “current assets” section.
Calculate the sum of these assets using the calculator. For example, add $1,000 plus $1,200 plus $2,000 for a company with $1,000 in cash, $1,200 in short-term investments and $2,000 in accounts receivable. This equals $4,200.
Use the calculator to divide $4,200 by the company’s current liabilities, which is found in the “liabilities” section of the balance sheet. For example, a company with $3,500 in current liabilities has a quick ratio of 1.2: $4,200 divided by $3,500 equals 1.2. Since the ratio is greater than one, this company has enough current assets to meet its short-term financial obligations without relying on its inventory.
- CliffsNotes: Ratio Analysis
- PrinciplesofAccounting.com; Chapter Four: The Reporting Cycle; Larry Walther, Ph.D., CPA, CMA; 2010
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