Acid Test Ratio

Understanding the Acid Test Ratio

The acid test ratio, also known as the quick ratio test, is a financial metric that compares a company’s short-term assets to its short-term liabilities.

Its purpose is determining whether a company has sufficient cash to cover its immediate obligations.

The ratio disregards assets that are not readily convertible to cash, such as inventory, and considers industry norms and specific business models.

This ratio provides valuable insights into a company’s financial stability and liquidity.

Importance and Applications

The acid test ratio assesses a company’s ability to meet its current liabilities without relying on additional financing.

It is beneficial for current stakeholders, including suppliers, lenders, and prospective investors, as it offers an understanding of the company’s financial position.

The ratio provides a conservative estimate of a company’s financial health by excluding inventory from the calculation.