Acid-test ratio
Definition
The acid-test ratio, also known as the quick ratio, measures a company's ability to pay off its current liabilities without relying on the sale of inventory. It is calculated by dividing quick assets (cash, marketable securities, and receivables) by current liabilities.
5 Must Know Facts For Your Next Test
- The acid-test ratio excludes inventory from current assets because inventory may not be quickly convertible to cash.
- A ratio of 1 or higher typically indicates that a company has sufficient liquidity to cover its short-term liabilities.
- Quick assets include cash, marketable securities, and accounts receivable but exclude inventories and prepaid expenses.
- The acid-test ratio provides a more stringent assessment of liquidity compared to the current ratio.
- Industries with fast inventory turnover might have low acid-test ratios yet still maintain strong liquidity.
Review Questions
- What components are included in quick assets for calculating the acid-test ratio?
- Why is inventory excluded when calculating the acid-test ratio?
- What does an acid-test ratio of less than 1 indicate about a company's financial health?
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Related terms
Current Ratio: A liquidity ratio that measures a company's ability to cover its short-term obligations with its current assets.
Working Capital: The difference between a company's current assets and current liabilities.
Liquidity: The ability of a company to meet its short-term financial obligations.
