What the Acid Test Ratio is All About
The Acid Test ratio, commonly called the Quick Ratio, is simply a stricter version of the current ratio. Instead of including all current assets, this ratio only allows highly liquid assets that can be converted into cash. This provides a better understanding if a company is able to pay its short term liabilities because it does not include things like inventory and prepaid expenses, which can not easily be liquidated.
Formula: (Cash + Accounts Receivable + Marketable Securities) ÷ Current Liabilities
Alternate Formula: (Current Assets – Inventory) ÷ Current Liabilities
The alternate formula is commonly used by small business retailers.
Cash, Accounts Receivable, and Marketable Securities can all be found in the current assets section of the balance sheet. Marketable securities may also be called “Short Term Investments”. Basically, anything that can be converted into cash rapidly should be included in acid test.
Acid Test Ratio (Quick Ratio) Calculator
What is a Good Acid Test Ratio for a Company?
In most cases, businesses should be able to pass the “Acid Test” with a 1 or higher. Any less than 1 and the company is in the danger zone for defaulting on their near term obligations.