Definition
Also known as the quick ratio, the acid test is a liquidity ratio, which measures a company's ability to convert assets into cash to pay its debt obligations over the next 12 months. The quick assets used by this measure are those that can be quickly converted into cash, thereby making it a more rigorous test of liquidity than the current ratio.
Calculation
Acid Test = Quick Assets / Current Liabilities
Where:
Quick Assets = Cash + Marketable Securities + Accounts Receivable
Current Liabilities = Accounts Payable + Income Taxes Payable + Current Portion of Long Term Debt
Explanation
Since inventory and prepaid expenses are removed from current assets, this ratio does not have to be as high as the current ratio. Generally, a value of 1.0 or higher is considered acceptable, while a value less than 1.0 is problematic. A ratio that is too high may indicate the inefficient use of current assets.
When drawing conclusions about the relative performance of a company, benchmark comparisons should be made with competitors in the same industry.
Example
Last year, Company A's balance sheet indicated cash and cash equivalents of $2,219,000, short-term investments of $1,416,000, and net receivables of $3,867,000. Accounts payable stood at $2,674,000, the current portion of long term debt was $682,000, and other current liabilities were $2,085,000.
Using the above formula, the acid test measure is:
= ($2,219,000 + $1,416,000 + $3,867,000) / ($2,674,000 + $682,000 + $2,085,000) = $7,502,000 / $5,441,000, or 1.38
Based on this information, we know Company A's quick ratio is above 1.0, which is considered acceptable.
Related Terms
A financial metric that is used to measure a company's ability to repay its short term debt obligations is called a liquidity ratio. The three most common liquidity ratios include the current, quick, and the cash ratio.
Moneyzine EditorJanuary 23rd, 2024
The current ratio is a measure of liquidity. The calculation only requires two inputs from the balance sheet: current assets and current liabilities. The current ratio measures a company's ability to pay debt coming due in the next 12 months.Moneyzine EditorJanuary 12th, 2024- Also known as the acid test, the quick ratio is a measure of liquidity, which is the ability of a company to pay its short term debt obligations using a subset of current assets known as quick assets. The calculation of the quick ratio requires information found on a company's balance sheet.Moneyzine EditorSeptember 21st, 2023
- The financial accounting term quick asset is used to describe a subset of current assets used in the calculation of the quick ratio, also known as the acid test. Quick assets include those assets that can reasonably be used to pay current liabilities. This includes cash, marketable securities, and accounts receivable.Moneyzine EditorSeptember 21st, 2023
