# Introduction to Acid Test Ratio.

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 Introduction to Acid Test Ratio.

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Introduction to Acid Test Ratio. - August 7th, 2013

A measure of a company's ability to meet its short-term obligations using its most liquid assets. It is calculated by subtracting inventories from current assets and dividing the quantity by its current liabilities. A higher acid-test ratio indicates greater short-term financial health. The acid-test ratio is more conservative than the current ratio, which measures much the same thing, because the current ratio excludes the value of inventory. This is because inventory can be less liquid than other current assets. The acid-test ratio thus measures a company's ability to meet obligations in a worst-case scenario. It is also called the quick ratio.

A stringent test to determine whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory; the acid-test ratio is far more strenuous than the working capital ratio because the working capital ratio allows for the inclusion of inventory assets.

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.

How to Calculate Acid Test Ratio:-

1)Find cash, short-term investments and accounts receivable on a company's balance sheet listed in the "current assets" section.

2) 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.

3) 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.

Example
:-

Assets Liabilities

Cash = 1000
Accounts payable = 500
Accounts receivable = 1000
Other short-term liabilities = 500
Inventory = 200
Current assets = 2200
Current Liabilities = 1000

Acid test ratio = (2200-200)/1000 = 2

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 Re: Introduction to Acid Test Ratio.
Jitendra Mazee

Student of Bachelor of Engineering at RGTU Bhopal

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Re: Introduction to Acid Test Ratio. - April 18th, 2016

Quote:
 Originally Posted by tejas.gaikwad.1044 A measure of a company's ability to meet its short-term obligations using its most liquid assets. It is calculated by subtracting inventories from current assets and dividing the quantity by its current liabilities. A higher acid-test ratio indicates greater short-term financial health. The acid-test ratio is more conservative than the current ratio, which measures much the same thing, because the current ratio excludes the value of inventory. This is because inventory can be less liquid than other current assets. The acid-test ratio thus measures a company's ability to meet obligations in a worst-case scenario. It is also called the quick ratio. A stringent test to determine whether a firm has enough short-term assets to cover its immediate liabilities without selling inventory; the acid-test ratio is far more strenuous than the working capital ratio because the working capital ratio allows for the inclusion of inventory assets. 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. How to Calculate Acid Test Ratio:- 1)Find cash, short-term investments and accounts receivable on a company's balance sheet listed in the "current assets" section. 2) 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. 3) 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. Example :- Assets Liabilities Cash = 1000 Accounts payable = 500 Accounts receivable = 1000 Other short-term liabilities = 500 Inventory = 200 Current assets = 2200 Current Liabilities = 1000 Acid test ratio = (2200-200)/1000 = 2
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