Acid Test Ratio

Business, Legal & Accounting Glossary

Definition: Acid Test Ratio


Acid Test Ratio

Quick Summary of Acid Test Ratio


The ratio of liquid assets to current liabilities.




What is the dictionary definition of Acid Test Ratio?

Dictionary Definition


A financial ratio similar to the current ratio or working capital ratio, defined as: current assets minus stocks divided by current liabilities. It shows whether a company would be able to pay its debts if it needed to satisfy creditors but it had no time to sell any of its assets.


Full Definition of Acid Test Ratio


The acid-test ratio, also known as the quick ratio, examines a company’s balance sheet data to determine whether it has enough short-term assets to cover its short-term liabilities.

  • The acid-test, also known as the quick ratio, compares a company’s most short-term assets to its most short-term liabilities to determine whether or not the company has enough cash to pay its immediate liabilities, such as short-term debt.
  • Current assets that are difficult to liquidate quickly, such as inventory, are excluded from the acid-test ratio.
  • If a company has accounts receivable that take longer than usual to collect or current liabilities that are due but do not require immediate payment, the acid-test ratio may not provide a reliable picture of its financial condition.

Analysts prefer the acid-test ratio over the current ratio (also known as the working capital ratio) in some situations because the acid-test method ignores assets like inventory, which can be difficult to liquidate quickly. As a result, the acid test ratio is a more conservative measurement.

Companies with an acid-test ratio of less than one have insufficient liquid assets to cover their current liabilities and should be avoided. If the acid-test ratio is significantly lower than the current ratio, a company’s current assets are heavily reliant on inventory.

This isn’t always a bad sign, though, because some business models are inherently inventory-dependent. Retail stores, for example, may have extremely low acid-test ratios without being in jeopardy. The acceptable range for an acid-test ratio varies by industry, and comparisons are most useful when comparing peer companies in the same industry.

The acid-test ratio should be greater than one in most industries. A high ratio, on the other hand, isn’t always a good thing. It could mean that money has accumulated and is sitting idle rather than being re-invested, returned to shareholders, or put to other productive use.

Some tech companies generate enormous cash flows, resulting in acid-test ratios of 7 or 8. While this is certainly preferable to the alternative, activist investors who prefer that shareholders receive a portion of the profits have criticised these companies.


Examples of Acid Test Ratio in a sentence


The larger the acid-test ratio, the better able the business is to pay its current liabilities.
In general, an acid-test ratio of 1.00 is considered safe.
The acid-test ratio assumes that all current liabilities are payable immediately and that the debtor will convert the most liquid assets to cash.

Synonyms For Acid Test Ratio


Quick Ratio


Acid Test Ratio FAQ's


What Is The Acid Test Ratio?

The ratio of current assets less inventories to total current liabilities.

This ratio is the most stringent measure of how well the company is covering its short-term obligations, since the ratio only considers that part of current assets that can be turned into cash immediately (thus the exclusion of inventories). The ratio tells creditors how much of the company’s short-term debt can be met by selling all the company’s liquid assets at very short notice. also called the acid-test ratio.

How To Calculate The Acid Test Ratio?

The numerator of the acid-test ratio can be defined in a variety of ways, but the most important thing to remember is to get a realistic picture of the company’s liquid assets. Cash and cash equivalents, as well as short-term investments like marketable securities, should all be included.

Accounts receivable are commonly included, but this is not appropriate in all industries. Accounts receivable, for example, may take much longer to recover in the construction industry than in other industries, so including it could make a company’s financial position appear much more secure than it is in reality.

The formula is as follows:

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

The numerator can also be calculated by taking all current assets and subtracting illiquid assets. Most importantly, inventory should be subtracted, keeping in mind that, due to the amount of inventory carried by retail businesses, this will negatively skew the picture. Other assets on a balance sheet, such as advances to suppliers, prepayments, and deferred tax assets, should be subtracted if they cannot be used to cover liabilities in the short term.

All current liabilities, which are debts and obligations due within one year, should be included in the ratio’s denominator. It’s worth noting that time isn’t taken into account when calculating the acid-test ratio. If a company’s accounts payable are approaching the due date but its receivables are months away, the company may be in much worse shape than its ratio suggests. It’s also possible that the opposite is true.

What's the Difference Between The Current and Acid-Test Ratios?

The current ratio, also known as the working capital ratio, and the acid-test ratio both assess a company’s ability to generate enough cash in the short term to pay off all of its debts if they all came due at the same time. The acid-test ratio, on the other hand, is considered more conservative than the current ratio because it excludes items like inventory, which can be difficult to liquidate quickly. Another significant distinction is that the acid-test ratio only considers assets that can be converted to cash in 90 days or less, whereas the current ratio considers assets that can be converted to cash in one year.

What Does the Acid-Test Ratio Tell You?

The acid test, also known as the quick ratio, determines whether a company has or can obtain sufficient cash to pay off its immediate liabilities, such as short-term debt. The acid-test ratio should be greater than one in most industries. If it’s less than one, the company doesn’t have enough liquid assets to cover its current liabilities, and it should be avoided. If the acid-test ratio is significantly lower than the current ratio, a company’s current assets are heavily reliant on inventory. A high ratio, on the other hand, may indicate that cash has accumulated and is not being reinvested, returned to shareholders, or otherwise put to productive use.

How to Calculate the Acid-Test Ratio?

Divide a company’s current cash, marketable securities, and total accounts receivable by its current liabilities to get the acid-test ratio. The balance sheet of the company contains this information.

While the numerator variables can be changed, each variation should reflect the most accurate picture of the company’s liquid assets. Cash and cash equivalents, as well as short-term investments like marketable securities, should be included. Because this figure is not appropriate for every industry, accounts receivable is sometimes excluded from the calculation. All current liabilities, which are debts and obligations due within one year, should be included in the ratio’s denominator.


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Definition Sources


Definitions for Acid Test Ratio are sourced/syndicated and enhanced from:

  • A Dictionary of Economics (Oxford Quick Reference)
  • Oxford Dictionary Of Accounting
  • Oxford Dictionary Of Business & Management

This glossary post was last updated: 25th January, 2022 | 0 Views.