The acid-test ratio, also known as the quick ratio, is a liquidity ratio that measures a company’s ability to meet its short-term obligations (debt) using its most liquid assets. It is calculated by dividing the sum of cash, marketable securities, and accounts receivable by current liabilities.
Formula:
Acid Ratio = (Cash + Marketable Securities + Accounts Receivable) / Current Liabilities
Interpretation:
A higher acid ratio indicates that a company has more liquid assets to meet its short-term obligations.
A lower acid ratio indicates that a company may have difficulty meeting its short-term obligations.
Example:
A company has the following assets and liabilities:
- Cash: @ 10,000
- Marketable securities: @ 20,000
- Accounts receivable: @ 30,000
- Current liabilities: @ 50,000
The company’s acid ratio would be calculated as follows:
Acid Ratio = (10,000 + 20,000 + 30,000) / 50,000 = 1.2
This means that the company has @1.20 in liquid assets for every @ 1.00 in current liabilities.
Guidelines:
There is no one-size-fits-all answer to the question of what a good acid ratio is, as it will vary depending on the industry in which a company operates. However, a good rule of thumb is to aim for an acid ratio of at least 1.0. This means that the company has enough liquid assets to cover its short-term obligations.
Limitations:
The acid ratio is just one measure of a company’s liquidity. It is important to consider other factors, such as the company’s cash flow statement and its ability to borrow money, when assessing its overall financial health.