What is acid test ratio?

The acid test ratio is also known as the quick ratio is similar to the current ratio except that Inventory, Supplies, and Prepaid Expenses are excluded. In other words, the acid test ratio compares the total of the cash, temporary marketable securities, and accounts receivable to the amount of current liabilities.The acid test ratio illustrated by assuming that a company has cash of $7,000 + temporary marketable securities of $20,000 + accounts receivables of $93,000. This adds up to $120,000 of quick assets. If its current liabilities amount to $100,000 its acid test ratio is 1.2:1.The larger the acid test ratio, the more easily will the company be able to meet its current obligations.

Based on accounting principles, The quick ratio matches the most easily liquidated portions of current assets with current liabilities. It is used to evaluate whether a business has sufficient assets that can be converted into cash to pay its bills. The key elements of current assets that are included in the quick ratio are cash, marketable securities, and accounts receivable. Inventory is not included in the ratio, since it can be quite difficult to sell off in the short term, and possibly at a loss. Because of the exclusion of inventory from the formula, the quick ratio is a better indicator than the current ratio of the ability of a company to pay its immediate obligations.

To calculate the quick ratio, summarize cash, marketable securities and trade receivables, and divide by current liabilities. Do not include in the numerator any excessively old receivables that are not likely to be paid. The formula is:

Cash + Marketable securities + Accounts receivable % Current liabilities 

Despite the absence of inventory from the calculation, the quick ratio may still not yield a good view of immediate liquidity, if current liabilities are payable right now, while receipts from receivables are not expected for several more weeks.

The ratio is most useful in manufacturing, retail, and distribution environments where inventory can comprise a large part of current assets. It is particularly useful from the perspective of a potential creditor or lender that wants to see if a credit applicant will be able to pay in a timely manner, if at all.

For example, Rapunzel Hair Products appears to have a respectable current ratio of 4:1.  The breakdown of the components of that ratio are:

Account                                / Amount

Cash                                       $100,000

Marketable securities             $50,000

Accounts receivable             $420,000

Inventory                              $3,430,000

Current liabilities                 $1,000,000

Current ratio                            4:1

Quick ratio                             0.57:1

The component breakdown reveals that nearly all of Rapunzel's current assets are in the inventory area, where short-term liquidity is questionable. This issue is only visible when the quick ratio is substituted for the current ratio.

The Quick Ratio is sometimes called the "acid-test" ratio and is one of the best measures of liquidity. Quick Ratio or Acid Test Ratio = Quick Assets/ Current Liabilities  

Where,   Quick Assets   = Current Assets −Inventories  

         Current Liabilities = As mentioned under Current Ratio.

The Quick Ratio is a much more conservative measure of short-term liquidity than the Current Ratio. It helps answer the question: "If all sales revenues should disappear, could my business meet its current obligations with the readily convertible  quick funds on hand?" Quick Assets consist of only cash and near cash assets. Inventories are deducted from current assets on the belief that these are not ‘near cash assets’ and also because in times of financial difficulty inventory may be  saleable only at liquidation value. But in a seller’s market inventories are also near cash assets.  An acid-test of 1:1 is considered satisfactory unless the majority of "quick assets" are in accounts receivable, and the pattern of accounts receivable collection lags behind the schedule for paying current liabilities.

This ratio also called quick ratio or liquidity ratio it measures the ability of the company to use its liquid assets which is near to cash that's the reason while calculating this ratio we deduct the inventory from the Current Assets than divide it by the Current liability. This is the strong indicator which shows that the company have sufficient liquid assets to covers its immediate liability.

Thanks for invitation :- Acid test ratio is much more conservative. If all sales revenue is disappeared could business meet current obligations with readily convertible quick fund in hand. Quick assets consist of only cash and near cash assets. Inventories are deducted from current assets on the believe there are not near cash assets. But in a sellers market inventories are also near cash assets. Acid test ratio = quick assets / current liabilities. Quick assets = current assets - inventories, Current liabilities = creditors of goods and services + short term loan + bank overdraft + cash credit + outstanding expenses +provision for taxation + proposed dividend + unclaimed dividend, Current assets = inventories +sundry debtors + cash and bank + receivable /accruals + loan and advances + disposal investment.

The acid-test ratio is a  indicator to know the current assets for covering current liabilities

The acid-test ratio is a strong indicator of whether a firm has sufficient short-term assets to cover its immediate liabilities

agree with answers >>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>>

Thank u

i agree with experts explanations

Thanks for the invite I am waiting for answers to relevant experts

Acid-Test Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities

A common alternative formula is:

Acid-Test Ratio = (Current assets – Inventory) / Current Liabilities

The acid-test ratio is a more conservative version of another well-known liquidity metric -- the current ratio. Although the two are similar, the Acid-Test ratio provides a more rigorous assessment of a company's ability to pay its current liabilities. It does this by eliminating all but the most liquid of current assets from consideration. Inventory is the most notable exclusion, because it is not as rapidly convertible to cash and is often sold on credit. Some analysts include inventory in the ratio, though, if it is more liquid than certain receivables.

wait more details from our experts